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Ikanos Communications 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 


FORM 10-Q

 


(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

Commission File Number: 0-51532

 


IKANOS COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   73-1721486

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

47669 Fremont Boulevard

Fremont, CA 94538

(Address of principal executive office and zip code)

(510) 979-0400

(Registrant’s telephone number including area code)

 


Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) had been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer  ¨                    Accelerated filer  x                     Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the Registrant’s Common Stock, $ 0.001 par value, was 29,200,892 as of October 16, 2007.

 



Table of Contents

IKANOS COMMUNICATIONS, INC.

FORM 10-Q

TABLE OF CONTENTS

 

          Page No.

PART I:

   FINANCIAL INFORMATION   

Item 1.

   Financial Statements (unaudited)    2
   Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006    2
   Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and October 1, 2006    3
   Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and October 1, 2006    4
   Notes to Unaudited Condensed Consolidated Financial Statements    5

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    13

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    21

Item 4.

   Controls and Procedures    21

PART II:

   OTHER INFORMATION   

Item 1.

   Legal Proceedings    21

Item 1A.

   Risk Factors    22

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    34

Item 4.

   Submission of Matters to a Vote of Security Holders    34

Item 6.

   Exhibits    34

Signatures

      34

 

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Table of Contents

PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands and unaudited)

 

     September 30,
2007
   December 31,
2006
Assets      

Current assets:

     

Cash and cash equivalents

   $ 59,982    $ 49,329

Short-term investments

     39,317      60,309

Accounts receivable, net of allowances of $39 and $149, respectively

     12,618      15,140

Inventories

     13,036      12,801

Prepaid expenses and other current assets

     3,400      3,086
             

Total current assets

     128,353      140,665

Property and equipment, net

     14,882      18,073

Intangible assets, net

     7,206      10,212

Goodwill

     6,247      6,247

Other assets

     1,699      660
             
   $ 158,387    $ 175,857
             
Liabilities and Stockholders’ Equity      

Current liabilities:

     

Accounts payable

   $ 16,530    $ 14,466

Accrued liabilities

     16,978      16,696

Capital lease obligations, current portion

     —        818
             

Total current liabilities

     33,508      31,980

Capital lease obligations

     —        987
             

Total liabilities

     33,508      32,967

Commitments and contingencies (Note 9)

     

Stockholders’ equity

     124,879      142,890
             
   $ 158,387    $ 175,857
             

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data, and unaudited)

 

     Three Months Ended     Nine Months Ended  
     September 30,
2007
    October 1,
2006
    September 30,
2007
    October 1,
2006
 

Revenue

   $ 27,275     $ 36,670     $ 77,601     $ 113,687  
                                

Costs and operating expenses:

        

Cost of revenues (1)

     17,190       23,051       47,060       66,687  

Research and development (2)

     13,908       12,912       38,940       40,011  

Selling, general and administrative (3)

     6,832       5,825       20,973       17,520  

Restructuring charges

     3,468       —         3,468       —    

Common stock offering expenses

     —         —         —         954  
                                

Total cost and operating expenses

     41,398       41,788       110,441       125,172  
                                

Loss from operations

     (14,123 )     (5,118 )     (32,840 )     (11,485 )

Interest income, net

     1,226       1,484       3,851       3,788  
                                

Loss before provision for income taxes

     (12,897 )     (3,634 )     (28,989 )     (7,697 )

Provision for income taxes

     70       (70 )     224       153  
                                

Loss before cumulative effect of change in accounting principle

     (12,967 )     (3,564 )     (29,213 )     (7,850 )

Cumulative effect of change in accounting principle, net of tax

     —         —         —         638  
                                

Net loss

   $ (12,967 )   $ (3,564 )   $ (29,213 )   $ (7,212 )
                                

Basic and diluted net loss per share:

        

Prior to cumulative effect of change in accounting principle, net of tax

   $ (0.45 )   $ (0.13 )   $ (1.03 )   $ (0.30 )

Cumulative effect of change in accounting principle, net of tax

     —         —         —         0.03  
                                

Net loss per share

   $ (0.45 )   $ (0.13 )   $ (1.03 )   $ (0.27 )
                                

Weighted average number of shares, basic and diluted

     28,711       27,368       28,377       26,234  
                                

Includes stock-based compensation expense as follows:

        

(1)    Cost of revenues

   $ 38     $ 139     $ 125     $ 238  

(2)    Research and development

     2,067       1,387       5,814       3,250  

(3)    Selling, general and administrative

     1,459       1,034       4,446       2,643  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands and unaudited)

 

     Nine Months Ended  
     September 30,
2007
    October 1,
2006
 

Cash flows from operating activities:

    

Net loss

   $ (29,213 )   $ (7,212 )

Adjustments to reconcile net loss to net cash provided (used) by operating activities:

    

Depreciation and amortization

     5,565       4,273  

Stock-based compensation expense

     10,385       6,131  

Amortization of intangible assets and acquired technology

     3,006       7,092  

Purchased in-process research and development

     —         3,512  

Cumulative effect of change in accounting principle

     —         (638 )

Loss on disposal of property and equipment

     1,384       —    

Changes in assets and liabilities, net of effect of acquisitions:

    

Accounts receivable

     2,522       (16,643 )

Inventories

     (235 )     3,289  

Prepaid expenses and other assets

     (1,353 )     (586 )

Accounts payable and accrued liabilities

     548       14,895  
                

Net cash provided (used) by operating activities

     (7,391 )     14,113  
                

Cash flows from investing activities:

    

Purchases of property and equipment

     (3,758 )     (11,528 )

Purchases of investments

     (35,036 )     (83,578 )

Maturities and sales of investments

     56,000       26,666  

Acquisitions, net of cash acquired

     —         (34,925 )
                

Net cash provided (used) by investing activities

     17,206       (103,365 )
                

Cash flows from financing activities:

    

Net proceeds from public offerings

     —         48,538  

Net proceeds from issuances of common stock and exercise of stock options

     1,436       2,741  

Payments of obligations under capital lease

     (617 )     (848 )

Collection of notes receivable from stockholder

     19       —    

Payment of notes payable

     —         (520 )
                

Net cash provided by financing activities

     838       49,911  
                

Net increase (decrease) in cash and cash equivalents

     10,653       (39,341 )

Cash and cash equivalents at beginning of period

     49,329       91,932  
                

Cash and cash equivalents at end of period

   $ 59,982     $ 52,591  
                

Supplemental disclosures of non-cash investing and financing activities:

    

Property and equipment acquired under capital leases

   $ —       $ 2,373  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

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Table of Contents

IKANOS COMMUNICATIONS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Ikanos and Summary of Significant Accounting Policies

The Company

Ikanos Communications, Inc. (“Ikanos,” or the “Company”) was incorporated in the State of California in April 1999 and reincorporated in the State of Delaware in September 2005. The Company is a global provider of high-performance silicon and software for interactive broadband. The Company develops and markets end-to-end solutions for the last mile and the digital home, which enable carriers to offer enhanced triple play services, including voice, video and data. The Company has developed programmable, scalable chip architectures, which form the foundation for deploying and delivering triple play services. Expertise in the creation and integration of unique DSP algorithms with advanced digital, mixed signal and analog semiconductors enables the Company to offer high-performance, high-density and low power VDSLx products. Flexible network processor architecture with wire-speed packet processing capabilities enables high-performance residential gateways for distributing advanced services in the home. These solutions thus support carriers’ triple play deployment plans to the digital home while keeping their capital and operating expenditures low and have been deployed by carriers in Asia, Europe and North America.

The Company’s fiscal year ends on the Sunday closest to December 31. The Company’s fiscal quarters end on the Sunday closest to the end of the applicable calendar quarter, except in a 53-week fiscal year, in which case the additional week falls into the fourth quarter of that fiscal year. The condensed consolidated balance sheet as of December 31, 2006 is derived from the audited financial statements as of that date.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared without audit in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 7, 2007.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to state fairly our financial position, results of operations and cash flows for the interim periods presented. The operating results for the three and nine month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 30, 2007 or for any other future period.

Use of Estimates

The preparation of the Company’s consolidated financial statements in conformity with GAAP requires management to make certain estimates, judgments and assumptions. The Company believes that the estimates, judgments and assumptions upon which it relies are reasonable based upon information available to it at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates and actual results, the Company’s financial statements would have been affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.

Adoption of New Pronouncements

In the first quarter of 2007, the Company adopted the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes–An Interpretation of FASB Statement No. 109 (“FIN 48”). See “Note 8: Income Taxes” for further discussion.

 

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Table of Contents

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. Cash, cash equivalents and short term investments are held with a limited number of financial institutions. Deposits held with these financial institutions may exceed the amount of insurance provided on such deposits. Management believes that the financial institutions that hold the Company’s investments are credit worthy and, accordingly, minimal credit risk exists with respect to those investments. Short-term investments include a diversified portfolio of commercial paper, auction rate certificates and government agency bonds. All investments are classified as available-for-sale. The Company does not hold or issue financial instruments for trading purposes.

Credit risk with respect to accounts receivable is concentrated due to the number of large orders recorded in any particular reporting period. Three customers represented 45%, 12% and 11% of accounts receivable at September 30, 2007. Three customers represented 47%, 25% and 10% of accounts receivable at December 31, 2006. Four customers accounted for 31%, 22%, 20% and 12%, of revenue for the three months ended September 30, 2007. Four customers accounted for 32%, 23%, 18% and 13% of revenue for the three months ended October 1, 2006. Four customers accounted for 30%, 21%, 17% and 12% of revenue for the nine months ended September 30, 2007. Four customers accounted for 23%, 22%, 22% and 20% of revenue for the nine months ended October 1, 2006.

Concentration of Other Risk

The semiconductor industry is characterized by rapid technological change, competitive pricing pressures and cyclical market patterns. The Company’s results of operations are affected by a wide variety of factors, including general economic conditions; economic conditions specific to the semiconductor industry; demand for the Company’s products; the timely introduction of new products; implementation of new manufacturing technologies; manufacturing capacity; the availability of materials and supplies; competition; the ability to safeguard patents and intellectual property in a rapidly evolving market; and reliance on assembly and wafer fabrication subcontractors and on independent distributors and sales representatives. As a result, the Company may experience substantial period-to-period fluctuations in future periods due to the factors mentioned above or other factors.

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business during a period from transactions and other events and circumstances from non-owner sources. The difference between the Company’s net loss and its total comprehensive loss for the three and nine months ended September 30, 2007 and October 1, 2006 was not material and related primarily to foreign currency translation and unrealized gains and losses on marketable securities.

Net Loss Per Share

Under the provisions of the Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per Share, basic net loss per share is computed using the weighted-average number of common shares outstanding during the period. Potentially dilutive securities have been excluded from the computation of diluted net loss per share if their inclusion is anti-dilutive.

The calculation of basic and diluted net loss per share is as follows (in thousands, except per share amounts):

 

     Three Months Ended     Nine Months Ended  
     September 30,
2007
    October 1,
2006
    September 30,
2007
    October 1,
2006
 

Net loss

   $ (12,967 )   $ (3,564 )   $ (29,213 )   $ (7,212 )
                                

Weighted average shares outstanding

     28,711       27,379       28,377       26,245  

Weighted average unvested shares of common stock subject to repurchase

     —         (11 )     —         (11 )
                                

Total shares – basic and diluted

     28,711       27,368       28,377       26,234  
                                

Basic and diluted net loss per share

   $ (0.45 )   $ (0.13 )   $ (1.03 )   $ (0.27 )
                                

 

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Table of Contents

The following potential common shares have been excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive (in thousands):

 

     Three Months Ended    Nine Months Ended
     September 30,
2007
   October 1,
2006
   September 30,
2007
   October 1,
2006

Anti-dilutive securities:

           

Warrants to purchase common stock

   —      6    —      6

Weighted average restricted stock units

   1,425    615    1,293    146

Weighted-average options to purchase common stock

   3,108    1,313    3,043    399
                   
   4,533    1,934    4,336    551
                   

Note 2. Short-Term Investments

The following is a summary of the Company’s short-term investments (in thousands):

 

     September 30, 2007
     Cost    Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair
Value

U.S. Treasury and other U.S. government agencies

   $ 23,187    $ 19    $ —       $ 23,206

Auction rate securities

     9,500      —        —         9,500

Corporate bonds and notes

     6,608      3      —         6,611
                            

Total short-term investments

   $ 39,295    $ 22    $ —       $ 39,317
                            
     December 31, 2006
     Cost    Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair
Value

U.S. Treasury and other U.S. government agencies

   $ 18,353    $ —      $ (19 )   $ 18,334

Auction rate securities

     41,906      69      —         41,975
                            

Total short-term investments

   $ 60,259    $ 69    $ (19 )   $ 60,309
                            

The Company’s marketable securities are classified as available-for-sale as of the balance sheet date and are reported at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity, net of tax. Realized gains and losses and permanent declines in value, if any, on available-for-sale securities are reported in other income or expense as incurred. Estimated fair values were determined for each individual security in the investment portfolio. The declines in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature.

A significant portion of the Company’s available-for-sale portfolio is composed of auction rate securities. Even though the stated maturity dates of these investments may be one year or more beyond the balance sheet dates, the Company has classified these securities as short-term investments. In accordance with Accounting Research Bulletin No. 43, Chapter 3A, Working Capital- Current Assets and Current Liabilities, the Company views its available-for-sale portfolio as available for use in its current operations. Based upon historical experience in the financial markets as well as the Company’s specific experience with these investments, the Company believes there is a reasonable expectation of completing a successful auction within the subsequent twelve-month period. During its history of investing in these securities, the Company generally has been able to sell its holdings of these investments at its discretion. Accordingly, the Company believes that the risk of non-redemption of these investments within a year is minimal.

Note 3. Inventories

Inventories consisted of the following (in thousands):

 

     September 30,
2007
   December 31,
2006

Finished goods

   $ 4,397    $ 4,858

Work-in-process

     7,469      7,359

Purchased parts and raw materials

     1,170      584
             
   $ 13,036    $ 12,801
             

 

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Table of Contents

Note 4. Property and Equipment

Property and equipment consisted of the following (in thousands):

 

     September 30,
2007
    December 31,
2006
 

Software

   $ 12,300     $ 14,883  

Machinery and equipment

     17,821       14,083  

Computer equipment

     5,132       4,984  

Furniture and fixtures

     865       850  

Leasehold improvements

     773       872  

Construction in progress

     148       372  
                
     37,039       36,044  

Less: Accumulated depreciation and amortization

     (22,157 )     (17,971 )
                
   $ 14,882     $ 18,073  
                

Depreciation and amortization expense for property and equipment was $1.9 million and $1.7 million for the three months ended September 30, 2007 and October 1, 2006, respectively. Depreciation and amortization expense for property and equipment was $5.6 million and $4.3 million for the nine months ended September 30, 2007 and October 1, 2006, respectively. Included in property and equipment are assets acquired under capital lease obligations, mostly software and machinery and equipment, with an original cost of $4.0 million and $6.1 million as of September 30, 2007 and December 31, 2006, respectively. Related accumulated depreciation and amortization of these assets was $3.7 million and $4.0 million as of September 30, 2007 and December 31, 2006, respectively.

Note 5. Intangible Assets

The carrying amount of intangible assets as of September 30, 2007 is as follows (in thousands):

 

     Gross Carrying
Amount
   Accumulated
Amortization
    Net
Amount
   Weighted
average
useful life
(Years)

Existing technology

   $ 6,145    $ (2,850 )   $ 3,295    4

Patents/core technology

     2,000      (813 )     1,187    4

Trademarks

     1,000      (347 )     653    5

Customer relationships

     3,070      (1,045 )     2,025    5

Order backlog

     1,200      (1,200 )     —      0.5

Non-competition agreement

     100      (54 )     46    3

Transition services

     594      (594 )     —      1

Favorable supply arrangement

     5,000      (5,000 )     —      1
                        

Total acquired intangible assets

   $ 19,109    $ (11,903 )   $ 7,206   
                        

 

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The carrying amount of intangible assets as of December 31, 2006 is as follows (in thousands):

 

     Gross Carrying
Amount
   Accumulated
Amortization
    Net
Amount
   Weighted
average
useful life
(Years)

Existing technology

   $ 6,145    $ (1,286 )   $ 4,859    4

Patents/core technology

     2,000      (438 )     1,562    4

Trademarks

     1,000      (187 )     813    5

Customer relationships

     3,070      (554 )     2,516    5

Order backlog

     1,200      (1,200 )     —      0.5

Non-competition agreement

     100      (29 )     71    3

Transition services

     594      (594 )     —      1

Favorable supply arrangement

     5,000      (4,609 )     391    1
                        

Total acquired intangible assets

   $ 19,109    $ (8,897 )   $ 10,212   
                        

For the three months ended September 30, 2007, and October 1, 2006, amortization of intangible assets were $1.0 million and $2.7 million, respectively. For the nine months ended September 30, 2007 and October 1, 2006, amortization of intangible assets were $3.0 million and $7.1 million, respectively. The estimated future amortization of purchased intangible assets as of September 30, 2007 is as follows (in thousands):

 

Remaining 2007

   $ 643

2008

     3,256

2009

     2,251

2010

     958

2011

     98
      
   $ 7,206
      

Note 6. Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

 

     September 30,
2007
   December 31,
2006

Accrued rebates

     4,082      3,586

Accrued compensation and related benefits

     3,161      3,601

Restructuring

     2,372      1,055

Accrued professional fees

     1,426      1,473

Warranty accrual

     1,106      2,774

Accrued royalties

     449      1,019

Other accrued liabilities

     4,277      3,188
             
   $ 16,873    $ 16,696
             

The following table summarizes the activity related to the warranty accrual (in thousands):

 

     Nine Months Ended  
     September 30,
2007
    October 1,
2006
 

Balance, beginning of period

   $ 2,774     $ 2,189  

Accrual for warranties during the period

     691       312  

Usage during the period

     (2,359 )     (547 )
                

Balance, end of period

   $ 1,106     $ 1,954  
                

 

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Note 7. Restructuring

Restructuring consisted of the following (in thousands):

 

     Severance
and benefits
    Excess
facilities
    Software
tools
    Total  

Balance as of December 31, 2006

   $ 873     $ 182     $ —       $ 1,055  

Restructuring charges

     578       —         2,890       3,468  

Cash payments

     (923 )     (132 )     —         (1,055 )

Asset write-off

     —         —         (2,179 )     (2,179 )

Liability write-off

     —         —         1,083       1,083  

Adjustments to the provision

     50       (50 )     —         —    
                                

Balance as of September 30, 2007

   $ 578     $ —       $ 1,794     $ 2,372  
                                

2007 Restructuring Action

During the third quarter of 2007, the Company implemented a restructuring program to reduce its cost structure. The restructuring plan involved outsourcing the back-end physical semiconductor design process and terminating approximately 16 employees, including four members of senior management. The Company expects to incur additional severance costs of $0.3 million to $0.5 million in the fourth quarter of 2007 related to this restructuring plan. The Company expects the remaining severance and benefits and software tool costs to be paid by the second quarter of 2009.

 

     Severance
and benefits
   Software
tools
    Total  

Balance as of December 31, 2006

   $ —      $ —       $ —    

Restructuring charges

     578      2,890       3,468  

Property and equipment write-off

     —        (1,361 )     (1,361 )

Prepaid expenses and other current assets write-off

     —        (818 )     (818 )

Capital lease obligations write-off

     —        1,083       1,083  
                       

Balance as of September 30, 2007

   $ 578    $ 1,794     $ 2,372  
                       

2006 Restructuring Action

During the fourth quarter of 2006, the Company implemented a restructuring program of its development operations to reduce its cost structure. The restructuring plan involved reducing the Company engineering workforce by approximately 42 employees of which approximately half were from India and half were from North America. In addition, the Company closed its Canadian office and transitioned those responsibilities to the United States through a combination of relocations and hiring. The Company incurred facility related expenses in relation to the lease termination of its Canadian office.

 

     Severance
and Benefits
    Excess
Facility
    Total  

Balance as of December 31, 2006

   $ 873     $ 182     $ 1,055  

Adjustment to the provision

     50       (50 )     —    

Cash payments

     (923 )     (132 )     (1,055 )
                        

Balance as of September 30, 2007

   $ —       $ —       $ —    
                        

 

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Note 8. Income Taxes

In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in any entity’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

The Company has adopted the provisions of FIN 48 as of January 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was $3.1 million. As a result of the implementation of FIN 48, the Company recognized no change in its liability for unrecognized tax benefits.

Included in the balance of unrecognized tax benefits as of January 1, 2007, are tax benefits of $0.1 million that, if recognized, would affect the effective tax rate and $3.0 million of benefits that would affect deferred tax assets. Future realization of such benefits is uncertain as of the date of adoption of FIN 48 because the Company’s deferred tax assets have a full valuation allowance. There were no significant changes to any of these amounts during the first nine months of 2007.

The Company has adopted the accounting policy that interest expense and penalties relating to income tax position are classified within the provision for income taxes. The total amount of interest and penalty recorded as of January 1, 2007 was not material.

The Company does not anticipate any significant changes within twelve months of this reporting date of its unrecognized tax benefits.

The Company’s operations are subject to income and transaction taxes in the United States and in multiple foreign jurisdictions. Significant estimates and judgments are required in determining the Company’s worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.

The Company is subject to taxation in the US and various states and foreign jurisdictions. There are no ongoing examinations by taxing authorities at this time. The Company’s tax years starting from 1999 to 2006 remain open in various tax jurisdictions.

There have been no material changes to the income tax positions, interest and penalties as of September 30, 2007.

Note 9. Commitments and Contingencies

Lease Obligations

The Company leases office facilities, equipment and software under non-cancelable operating leases with various expiration dates through 2011. Rent expense for the three months ended September 30, 2007 and October 1, 2006 was $0.3 million. Rent expense for the nine months ended September 30, 2007 and October 1, 2006 was $0.9 million. The terms of the facility leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid.

Future minimum lease payments as of September 30, 2007 under non-cancelable leases with original terms in excess of one year are summarized as follows (in thousands):

 

     Operating
Leases

Remaining 2007

   $ 399

2008

     1,922

2009

     1,239

2010

     664

2011

     168
      
   $ 4,392
      

Purchase Commitments

The Company entered into a technology access agreement in July 2007. Under terms of the agreement, the Company agreed to pay $0.4 million for the remainder of 2007, $1.9 million in 2008 and $0.5 million in 2009.

In February 2006, the Company assumed a royalty agreement in connection with the acquisition of the network processing and ADSL assets from ADI. Under terms of the agreement, the Company agreed to pay a minimum royalty fee of $0.7 million in 2008.

 

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In June 2007, the Company entered into a software development agreement. Under the terms of the agreement, the Company agreed to pay $0.2 million for the remainder of 2007 and $0.2 million in 2008.

As of September 30, 2007 the Company had $7.4 million of inventory purchase obligations with various suppliers.

Indemnities, Commitments and Guarantees

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property indemnities to the Company’s customers in connection with the sales of its products, indemnities for liabilities associated with the infringement of other parties’ technology based upon the Company’s products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the various agreements that include indemnity provisions. In addition, the Company requires its employees to sign a proprietary information and inventions agreement, which assigns the rights to its employees’ development work to the Company. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets. The Company does, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable and the amount of the loss can be reasonably estimated, in accordance with SFAS No. 5, Accounting for Contingencies.

In addition, the Company indemnifies its officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to its certificate of incorporation, bylaws, and applicable Delaware law. To date, the Company has not incurred any costs related to these indemnifications.

Litigation

In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, its directors, an executive officer and a former executive officer, as well as the lead underwriters for the Company’s initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint alleges certain material misrepresentations and omissions by the Company in connection with its initial public offering in September 2005 and the follow-on offering in March 2006 concerning its business and prospects, and seek unspecified damages. On June 25, 2007, the defendants filed motions to dismiss the amended complaint; plaintiffs opposed the motions and the matter is pending a decision by the court. The Company cannot predict the likely outcome of this litigation, and an adverse result could have a material effect on its financial statements. Additionally, from time to time the Company is a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, the Company does not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on its results of operations, cash flows or financial position.

Note 10. Related Party Transactions

The Company has a consulting agreement with Texan Ventures, LLC entered into during 2001. Pursuant to the consulting agreement, G. Venkatesh, who is both the Managing Member of Texan Ventures, LLC and a member of the Company’s Board of Directors provides consulting services with respect to, among other things, general business advice relating to the operation of a public company, guidance and strategic advice in analyzing acquisition opportunities, assisting in negotiations of acquisition agreements and providing assistance and guidance in the integration of acquired companies. Under the Consulting Agreement, Texan Ventures, LLC was entitled to $3,000 per month and reimbursement for reasonable expenses. In October 2006, the agreement was amended whereby Mr. Venkatesh served as Executive Chairman of the Company’s Board of Directors, expanding his advisory services to assist in tactical and operational decisions of the Company, while the Company searched for a permanent Chief Executive Officer. As a result of the amendment, the consulting fees paid to Texan Ventures, LLC increased to $18,000 per month, and Mr. Venkatesh received an option to purchase 125,000 shares of the Company’s common stock. In June 2007, the Company hired its permanent Chief Executive Officer, Michael Ricci. At that time, Mr. Venkatesh was appointed as Chairman of the Company, and Texan Ventures, LLC continued to receive $18,000 per month through July 2007, and $3,000 each month for August and September 2007. After September 2007, the consulting relationship ended with no further payments. The Company paid or is obligated to pay Texan Ventures, LLC $24,000 for the three months ended September 30, 2007 and $9,000 for the three months ended October 1, 2006. The Company paid or is obligated to pay Texan Ventures, LLC $132,000 for the nine months ended September 30, 2007 and $27,000 for the nine months ended October 1, 2006.

Note 11. Significant Customer Information and Segment Reporting

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The method for determining the information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance.

 

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The Company’s chief operating decision-maker is considered to be the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. On this basis, the Company is organized and operates in a single segment: the design, development, marketing and sale of semiconductors.

The following table summarizes revenue by geographic region, based on the country in which the customer headquarters office is located (in thousands):

 

     Three Months Ended    Nine Months Ended
     September 30,
2007
   October 1,
2006
   September 30,
2007
   October 1,
2006

Japan

   $ 15,409    $ 15,202    $ 37,649    $ 48,232

France

     4,486      12,006      17,589      26,440

Korea

     3,202      4,677      9,577      26,658

Other

     4,178      4,785      12,786      12,357
                           
   $ 27,275    $ 36,670    $ 77,601    $ 113,687
                           

Four customers accounted for more than 10% of the Company’s total revenue in the three and nine months ended September 30, 2007. Four customers accounted for more than 10% of the Company’s total revenue in the three and nine months ended October 1, 2006.

The Company divides its products into two product families: Access and Gateway. Access includes products that the Company sells on the carrier infrastructure side of the phone line while Gateway includes products that the Company sells into the residence. Revenue by product family is as follows (in thousand):

 

     Three Months Ended    Nine Months Ended
     September 30,
2007
   October 1,
2006
   September 30,
2007
   October 1,
2006

Access

   $ 15,143    $ 16,506    $ 41,693    $ 60,064

Gateway

     12,132      20,164      35,908      53,623
                           
   $ 27,275    $ 36,670    $ 77,601    $ 113,687
                           

The distribution of long-lived assets (excluding goodwill, intangible assets and other assets) as of September 30, 2007 and December 31, 2006 was as follows (in thousands):

 

     September 30,
2007
   December 31,
2006

United States

   $ 9,327    $ 10,776

India

     2,289      2,639

Taiwan

     1,344      2,125

Singapore

     1,278      1,514

Other

     644      1,019
             
   $ 14,882    $ 18,073
             

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in this discussion, as more fully described in Part II, Item 1.A “Risk Factors” in this Quarterly Report on Form 10-Q. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. These forward-looking statements include, without limitation, our expectation that a small number of OEMs will continue to account for a substantial portion of our revenue; our existing and expected cash, cash equivalents and cash flows will be sufficient to meet our anticipated cash needs for at least the next 12 months; our belief in the effectiveness of our internal

 

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controls; our expectation that significant customer concentration in a small number of OEM customers will continue for the foreseeable future; our expectation that our foreign currency exposure will increase as our operations in India and other countries expand; and future costs and expenses and financing requirements. The forward-looking statements made in this Form 10-Q are made as of the filing date with the Securities and Exchange Commission and future events or circumstances could cause results that differ significantly from the forward-looking statements included here. Accordingly, we caution readers not to place undue reliance on these statements and, except as required by law, we assume no obligation to update any such forward-looking statements.

The following discussion and analysis should be read in conjunction with the condensed financial statements and notes thereto in Part I, Item 1 above and with our financial statements and notes thereto for the year ended December 31, 2006, contained in our Annual Report on Form 10-K filed on March 7, 2006.

Overview

We are a leading global provider of high-performance silicon and software for interactive broadband. We develop and market end-to-end solutions for the last mile and the digital home, which enable carriers to offer enhanced triple play services, including voice, video and data. Our solutions power DSLAMs, ONUs, concentrators, customer premise equipment, modems and residential gateways for leading network equipment manufacturers. Our products have been deployed by carriers in Asia, Europe and North America. We believe that we can offer advanced products by continuing to push existing limits in silicon, systems and software. We have developed programmable, scalable chip architectures, which form the foundation for deploying and delivering triple play services. Expertise in the creation and integration of unique DSP algorithms with advanced digital, mixed signal and analog semiconductors enables us to offer high-performance, high-density and low power VDSLx products. Flexible network processor architecture with wire-speed packet processing capabilities enables high-performance residential gateways for distributing advanced services in the home. These industry-leading solutions thus support carriers’ triple play deployment plans to the digital home while keeping their capital and operating expenditures low.

We outsource all of our semiconductor fabrication, assembly and test functions, which enable us to focus on design, development, sales and marketing of our products and reduce the level of our capital investment. Our customers consist primarily of original design manufacturers, or ODMs, contract manufacturers, or CMs, and original equipment manufacturers, or OEMs, who in turn sell our semiconductors as part of their product solutions to carriers. We also sell to third-party sales representatives, who in turn sell to ODMs, CMs and OEMs. We were incorporated in April 1999 and through December 31, 2001, we were engaged principally in research and development. We began commercial shipment of our products in the fourth quarter of 2002. Over the last three years, our revenue increased from $66.7 million in 2004 to $85.1 million in 2005 to $134.7 million in 2006, resulting from increased deployment of broadband services by carriers primarily in Japan and Korea and, in 2006, our expansion into the residential gateway market via the NPA acquisition. Our revenue, however, can fluctuate significantly, even on a quarterly basis. For instance, in the first quarter of 2005, our revenue decreased $6.2, million or 33%, from the fourth quarter of 2004, yet in the second quarter of 2005, our revenue increased $7.0 million, or 57%, from the first quarter of 2005. More recently, in the third quarter of 2006, our revenue declined by $4.5 million, or 11%, from the second quarter of 2006 and in the fourth quarter of 2006, our revenue declined by $15.7 million, or 43%, from the third quarter of 2006. Quarterly fluctuations in revenue are a characteristic of our industry. And given our concentration of revenue among a few significant customers and given their buying patterns, we have experienced, and are likely to experience again, significant quarterly fluctuations of revenue. Specifically, carriers purchase equipment based on expected deployment and OEMs may occasionally manufacture equipment at rates higher than equipment is deployed. As a result, periodically and usually without significant notice, carriers will reduce orders with OEMs for new equipment and OEMs in turn will reduce orders for our products, which will adversely impact the quarterly demand for our products, even when deployment rates may be increasing.

In September 2005, we sold 6.4 million shares of our common stock in our initial public offering at $12.00 per share. Aggregate net proceeds from our initial public offering, after deducting underwriting discounts and commissions and issuance costs, were $67.9 million. We also had 15.3 million shares of redeemable convertible preferred stock outstanding that automatically converted into the same number of shares of our common stock upon the closing of our initial public offering.

In February 2006, we acquired network processing and ADSL assets from Analog Devices, Inc. (“ADI”) (“the NPA acquisition”) for $32.7 million in cash and began deriving revenue relating to network processing and ADSL products in the same quarter. This acquisition enabled us to enter the growing residential gateway semiconductor market and diversified our product offerings, allowing us to sell into new markets worldwide. As a result of the NPA acquisition, we incurred significant additional expenses related to the addition of employees and related expenses of developing and marketing products as well as non-cash acquisition-related charges.

In March 2006, we sold 2.5 million shares of our common stock in a follow-on offering at $20.75 per share. Aggregate net proceeds from the follow-on offering, after deducting underwriting discounts and commissions and issuance costs, were $48.5 million. In the follow-on offering, selling stockholders including members of our senior management sold 3.3 million shares of common stock held by them. We did not receive any proceeds from the sale of shares by the selling stockholders.

On June 4, 2007, Michael A. Ricci started as our new President and Chief Executive Officer, at which time Daniel K. Atler stepped down as our interim President and Chief Executive Officer.

 

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Critical Accounting Policies and Estimates

In preparing our condensed consolidated financial statements, we make assumptions, judgments, and estimates that can have a significant impact on amounts reported in our consolidated financial statements. We base our assumptions, judgments, and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates and make changes accordingly. We also discuss our critical accounting estimates with the Audit Committee of the Board of Directors. We believe that the assumptions, judgments and estimates involved in the accounting for revenue, cost of revenue, inventories, income taxes, impairment of goodwill, acquisitions and stock-based compensation expense have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results.

The critical accounting policies are described in Item 7, “Management Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the year ended December 31, 2006, and have not changed materially as of September 30, 2007 with the exception of the following:

Acquisitions

For accounting purposes, we are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as purchased in-process research and development (IPR&D) based on the estimated fair values. As further disclosed in Note 2 to the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2006, we use various models to determine the fair values of the assets acquired and liabilities assumed. These models include the discounted cash flow (“DCF”), the royalty savings method and the cost savings approach. The valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets as more fully disclosed in Note 2 as previously referenced.

Critical estimates in valuing certain of the intangible assets include, but are not limited to, future expected cash flows from customer contracts, customer lists, distribution agreements and acquired developed technologies and patents; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position as well as assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio; and discount rates. We derive our discount rates from our internal rate of return based on our internal forecasts and we may adjust the discount rate giving consideration to specific risk factors of each asset. Management’s estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

Results of Operations

Revenue

Our revenue is primarily derived from sales of our semiconductor products. Revenue from product sales is generally recognized upon shipment, net of sales returns, rebates and allowances. As is typical in our industry, the selling prices of our products generally decline over time. Therefore, our ability to increase revenue is dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in greater quantities. Our ability to increase unit sales volume is dependent primarily upon our ability to increase and fulfill current customer demand and obtain new customers.

Our products generally fall within two market-focused groups – Access and Gateway. Access includes products that we sell on the carrier infrastructure side, while Gateway includes product that sell into the digital home, which generally includes modems, integrated access devices (IADs) and residential gateways.

Revenue decreased by $9.4 million, or 26%, to $27.3 million for the three months ended September 30, 2007 from $36.7 million for the three months ended October 1, 2006. Revenue decreased by $36.1 million, or 32%, to $77.6 million for the nine months ended September 30, 2007 from $113.7 million for the nine months ended October 1, 2006. The majority of the decrease relates to an overall decline in volume of units sold relating to a number of factors, including an equipment correction in Japan as carriers slowed orders as they lowered their existing equipment levels, a product transition in Korea as carriers move to our 5th generation product platform as well as some market share loss to passive optical network (“PON”) technologies, and a lower volume of ADSL-based gateways being sold in Europe. A portion of the revenue decrease also related to a product shift in Japan from Access to Gateway products, whereby the Gateway products have a lower selling price than the Access products.

We generally sell our products to OEMs through a combination of our direct sales force and third-party sales representatives. Sales are generally made under short-term, non-cancelable purchase orders. We also have volume purchase agreements, and certain customers who provide us with non-binding forecasts. Although certain OEM customers may provide us with rolling forecasts, our ability to predict future sales in any given period is limited and subject to change based on demand for our OEM customers’ systems and their supply chain decisions.

Historically, a small number of OEM customers, the composition of which has varied over time, have accounted for a substantial portion of our revenue, and we expect that significant customer concentration will continue for the foreseeable future, but it may diversify across more carrier customers as we expect more carriers world-wide to begin deployments of VDSL2-based Access and Gateway products. The following customers accounted for more than 10% of our revenue for the periods indicated. Sales made to OEMs are based on information that we receive at the time of ordering.

 

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Table of Contents
          Three Months Ended     Nine Months Ended  

Our Direct Customer

  

OEM Customer

   September 30,
2007
    October 1,
2006
    September 30,
2007
    October 1,
2006
 

NEC Corporation (USA)

  

NEC Corporation (Magnus)

   31 %   23 %   30 %   22 %

Sagem

  

Sagem

   20 %   32 %   21 %   22 %

Altima

  

Sumitomo Electric Industries

   22 %   18 %   17 %   20 %

Uniquest

  

Various

   12 %   12 %   12 %   23 %

 

* less than 1%

Revenue by Product Family

 

     Three Months Ended    Nine Months Ended
     September 30,
2007
   October 1,
2006
   September 30,
2007
   October 1,
2006

Access

   $ 15,143    $ 16,506    $ 41,693    $ 60,064

Gateway

   $ 12,132    $ 20,164    $ 35,908    $ 53,623

For the three months ended September 30, 2007 as compared to the three months ended October 1, 2006, the change in mix is primarily attributed to decreased sales of our existing ADSL-based Gateway products in Europe as well as our decision to phase out of our ADSL modem only business. Sagem is our largest Gateway customer and as their sales decrease as a percentage of our total sales our sales mix is affected accordingly. For the nine months ended September 30, 2007 as compared to the nine months ended October 1, 2006, the mix between Gateway and Access has remained relatively consistent. The decrease in Access sales is mainly attributed to decreased average sales price and to a lesser extent, decreased units shipped. The decrease in Gateway is attributed to a decrease in units shipped.

Revenue by Country

 

     Three Months Ended    Nine Months Ended
     September 30,
2007
   October 1,
2006
   September 30,
2007
   October 1,
2006

Japan

   $ 15,409    $ 15,202    $ 37,649    $ 48,232

France

     4,486      12,006      17,589      26,440

Korea

     3,202      4,677      9,577      26,658

Other

     4,178      4,785      12,786      12,357
                           
   $ 27,275    $ 36,670    $ 77,601    $ 113,687
                           

The table above reflects sales to our direct customers based on where they are headquartered. It does not necessarily reflect carrier deployment of our products as we do not sell direct to them. For the three months ended September 30, 2007 compared to the three months ended October 1, 2006, revenue from France decreased by $7.5 million due to lower unit volume of our ADSL-based Gateway products sold to Sagem. Revenue from Korea decreased by $1.5 million as we lost a portion of our market share to carriers choosing to deploy some PON-based technology instead of VDSL in 2007.

For the nine months ended September 30, 2007 compared to the nine months ended October 1, 2006, revenue from Korea decreased by $17.1 million, which represents the greatest geographical decline for this period. The decrease is due to an OEM that ceased to manufacture product for carriers in Japan in 2006, a product transition to our 5th generation products in early 2007 and a loss of a portion of the market to PON-based technology. Japan revenue decreased by $10.6 million as overall volume declined and as we experienced a shift from Access to Gateway products, which have a lower average sales price. Revenue in France decreased $8.9 million due to lower volume shipped.

 

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Cost and Operating Expenses

 

     Three Months Ended     Nine Months Ended  
     September 30,
2007
   October 1,
2006
   %
Change
    September 30,
2007
   October 1,
2006
   %
Change
 

Cost of revenues

   $ 17,190    $ 23,051    (25 )%   $ 47,060    $ 66,687    (29 )%

Research and Development

     13,908      12,912    8       38,940      40,011    (3 )

Sales, general and administrative

     6,832      5,825    17       20,973      17,520    20  

Restructuring Charges

     3,468      —      —         3,468      —      —    

Common stock offering expenses

     —        —      —         —        954    —    

 

     Three Months Ended     Nine Months Ended  
     September 30,
2007
    October 1,
2006
    September 30,
2007
    October 1,
2006
 

Cost and Operating Expenses as a percentage of Total Revenue

        

Cost of revenue

   63 %   63 %   61 %   59 %

Research and Development

   51 %   35 %   50 %   35 %

Sales, general and administrative

   25 %   16 %   27 %   15 %

Restructuring Charges

   13 %   0 %   5 %   0 %

Cost of Revenue. Our cost of revenue consists primarily of silicon wafers purchased from third-party foundries and third-party costs associated with assembling, testing, and shipping of our semiconductors. Because we do not have formal, long-term pricing agreements with our outsourcing partners, our wafer costs and services are subject to price fluctuations based on the cyclical demand for semiconductors, among other factors. In addition, after we purchase wafers from foundries, we also incur yield loss related to manufacturing these wafers into “good” die. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested. When our manufacturing yields decrease our cost per unit increases which could have a significant adverse impact on our cost of revenue. Cost of revenue also includes accruals for actual and estimated warranty obligations and write-downs of excess and obsolete inventories, payroll and related personnel costs, depreciation of equipment, stock-based compensation expenses and amortization of acquisition-related intangibles.

Cost of revenue decreased to $17.2 million for the three months ended September 30, 2007 as compared to $23.1 million for the three months ended October 1, 2006. The decrease is primarily due to decreased sales this quarter as compared to the same period last year. Our gross margins (which we define as revenue minus cost of revenue divided by revenue) were consistent at 37% for the three months ended September 30, 2007 and October 1, 2006.

Cost of revenue decreased to $47.1 million for the nine months ended September 30, 2007 as compared to $66.7 million for the nine months ended October 1, 2006. The decrease is primarily due to decreased sales this quarter as compared to the same period last year. Our gross margins were 39% for the nine months ended September 30, 2007 as compared to 41% for the nine months ended October 1, 2006. The decrease in gross margins is primarily the result of a $1.6 million product feasibility study with a customer that we entered into in Q3 2007, which was an offset to revenue.

Research and development expenses. All research and development expenses are expensed as incurred and generally consist of compensation and associated costs of employees engaged in research and development; contractors; tape-out costs; reference board development; development testing, evaluation kits and tools; stock based compensation expenses; occupancy costs and depreciation expense. Before releasing new products, we incur charges for mask sets, amortization of acquisition-related intangibles, prototype wafers, mask set revisions, bring-up boards and other qualification materials, which we refer to as tape-out costs. Tape-out costs cause our research and development expenses to fluctuate because they are not incurred uniformly every quarter.

Research and development expenses increased by $1.0 million, or 8%, to $13.9 million for the three months ended September 30, 2007 as compared to $12.9 million for the three months ended October 1, 2006. The increase was primarily due to a $1.1 million increase in testing and tape-out costs, a $0.7 million increase in stock based compensation, and a $0.3 million increase in software costs. These increases were partially offset by a decrease in personnel costs of $0.6 million and a decrease in acquired in process research and development costs related to the Doradus acquisition of $0.6 million.

Research and development expenses decreased $1.1 million, or 3%, to $38.9 million for the nine months ended September 30, 2007 as compared to $40.0 million for the nine months ended October 1, 2006. The decrease was primarily due to in process research and development costs of $3.5 million in the nine months ended October 1, 2006 related to the NPA and Doradus acquisitions that were not included in the current period, as well as a $2.4 million decrease in testing and tape-out costs. These decreases were partially offset by increases in intellectual property costs and design tools of $1.8 million, stock-based compensation of $2.6 million and depreciation expense of $0.6 million.

 

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As of September 30, 2007, we had 193 people engaged in research and development of whom 101 were located in India and 92 were located in North America. As of October 1, 2006, we had 227 people engaged in research and development of whom 110 were located in India and 117 were located in North America.

Selling, general and administrative expenses. Selling, general and administrative, or SG&A, expenses increased by $1.0 million for the three months ended September 30, 2007, or 17%, to $6.8 million as compared to $5.8 million for the three months ended October 1, 2006. The increase is primarily attributable to additional personnel costs of $0.5 million and stock-based compensation expense of $0.4 million.

SG&A expenses increased by $3.5 million for the nine months ended September 30, 2007, or 20%, to $21.0 million as compared to $17.5 million for the nine months ended October 1, 2006. The increase is primarily attributable to additional personnel costs of $1.4 million, stock-based compensation expense of $1.8 million, depreciation expense of $0.6 million, facilities expense of $0.4 million and legal fees of $0.3 million. These increases were offset by a decrease in amortization of NPA acquisition intangibles of $1.2 million.

As of September 30, 2007, SG&A headcount was 84, which compares to 71 at October 1, 2006.

Restructuring Charges. During the third quarter of 2007, we incurred restructuring and severance expenses of $3.5 million as we outsourced our back-end physical semiconductor design process and terminated four members of senior management. The restructuring charges consist of approximately $2.9 million in contract termination costs and asset impairments and $0.6 million in severance costs. Since not all employees were communicated with prior to September 30, 2007, we expect to incur additional severance costs of $0.3 million to $0.5 million in the fourth quarter of 2007 related to this restructuring plan.

Common stock offering expenses. We incurred $1.0 million of common stock offering expenses in the nine months ended October 1, 2006 related to the proportionate share of expenses incurred by us on behalf of the selling stockholders in our common stock offering in March 2006.

Interest Income, Net

Interest income, net consists primarily of interest income earned on our cash, cash equivalents and short-term investments, which is partially offset by interest and other expense. Interest income, net was $1.2 million for the three months ended September 30, 2007 and $1.5 million for the three months ended October 1, 2006. Interest income, net increased to $3.9 million for the nine months ended September 30, 2007 as compared to $3.8 million for the nine months ended October 1, 2006.

Provision for Income Taxes

Income taxes are comprised of foreign, federal and state alternative minimum income taxes, and the provision for income taxes was $0.1 million for the three months ended September 30, 2007. For the three months ended October 1, 2006, we recorded an income tax benefit of $0.1 million. The provision for income taxes was $0.2 million for the nine months ended September 30, 2007 and October 1, 2006. Our income tax provision for the remainder of 2007 may fluctuate based upon our operating results for each taxable jurisdiction in which we operate and the amount of statutory tax that we incur in each jurisdiction.

Cumulative Effect of Change in Accounting Principle

The adoption of SFAS No. 123 (revised 2004), Share Based Payment (“SFAS 123(R)”) in 2006 resulted in a cumulative benefit of $0.6 million, which reflects the net cumulative impact of estimating future forfeitures in the determination of period expense, rather than recording forfeitures when they occur, as previously permitted.

Net Income/Net Loss

As a result of the above factors, we had a net loss of $13.0 million for the three months ended September 30, 2007 as compared to a net loss of $3.6 million for the three months ended October 1, 2006. For the nine months ended September 30, 2007 we had a net loss of $29.2 million as compared to a net loss of $7.2 million for the nine months ended October 1, 2006.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments decreased by $10.3 million to $99.3 million as of September 30, 2007 as compared to $109.6 million as of December 31, 2006. This decrease was primarily due to our cash used in operating activities of $7.3 million. As of September 30, 2007, we have funded our operations primarily through cash from offerings of our common stock, cash generated from the sale of our products and proceeds from the exercise of stock options and stock purchased under our employee stock purchase plan. Our uses of cash include payroll and payroll-related expenses, manufacturing costs, purchases of equipment, tools and software and operating expenses, such as tape outs, marketing programs, travel, professional services and facilities and related costs. We have also used cash to acquire businesses and technologies to expand our product offerings. We believe there will be additional working capital requirements to fund and operate our business. We expect to finance our operations primarily through operating cash flows and existing cash and investment balances. The following table summarizes our statement of cash flows for the nine months ended September 30, 2007 and October 1, 2006:

 

     September 30,
2007
    October 1,
2006
 
     (in millions)  

Statements of Cash Flows Data:

    

Cash and cash equivalents—beginning of period

   $ 49.3     $ 91.9  

Net cash provided by (used in) operating activities

     (7.3 )     14.1  

Net cash provided by (used in) investing activities

     17.2       (103.4 )

Net cash provided by financing activities

     0.8       50.0  
                

Cash and cash equivalents—End of period

   $ 60.0     $ 52.6  
                

 

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Operating Activities

For the nine months ended September 30, 2007, we used $7.3 million in net cash from operating activities, while incurring a net loss of $29.2 million. Included in the net loss was approximately $20.4 million in various non-cash expenses and charges consisting of depreciation and amortization, loss on disposal of property and equipment, stock based compensation expense and amortization of intangible assets and acquired technology. Operating cash flows also benefited from a decrease in accounts receivable of $2.5 million and an increase in accounts payable and accrued liabilities of $0.5 million. The decrease in accounts receivable was primarily due to more linearity of sales during the period. The increase in accounts payable and accrued liabilities is primary related to the timing of purchases and payments. These sources of operating cash flows were offset by an increase in prepaid expenses and other assets of $1.4 million. The increase in prepaid expenses and other assets was primarily due to prepaid rental fees.

For the nine months ended October 1, 2006, we generated $14.1 million of net cash from operating activities, while incurring a net loss of $7.2 million. Included in the net loss was approximately $20.4 million in various non-cash expenses and charges consisting of depreciation and amortization, stock based compensation expense, amortization of intangible assets and acquired technology, purchased IPR&D and the cumulative effect of changes in accounting principles. Operating cash flows also benefited from an increase in accounts payable and accrued liabilities of $14.9 million and a decrease in inventory of $3.3 million. The increase in accounts payable and accrued liabilities related principally to inventory purchases required to support a broader product portfolio and the timing of our payments to our suppliers. These sources of operating cash flows were offset by a $16.6 million increase in accounts receivable. The increase in accounts receivable and was caused primarily by an increase in the volume of our business. During the nine months ended September 30, 2006, cash receipts from customers increased to $97.0 million from $52.4 million in the same period in 2005, while cash payments to vendors and employees increased to $86.5 million from $44.7 million. These increases in both receipts and payments were due to the overall growth in our business as revenue increased from $56.5 million to $113.7 million in the same periods.

Investing Activities

We generated cash from investing activities of $17.2 million for the nine months ended September 30, 2007, primarily from the net sale of short-term investments totaling $21.0 million, offset by $3.8 million in purchases of property and equipment. We used net cash of $103.3 million for the nine months ended October 1, 2006, which related primarily to the NPA and Doradus acquisitions totaling $35.0 million, the net purchase of short-term investments totaling $56.9 million and purchases of property and equipment of $11.5 million. We anticipate that we will continue to purchase necessary property and equipment in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods depend on a number of factors, including the hiring of employees, the rate of change of computer hardware and software used in our business and our business outlook. We have classified our investment portfolio as “available for sale,” and our investment objectives are to preserve principal and provide liquidity, while maximizing yields without significantly increasing risk. We may sell an investment at any time if the quality rating of the investment declines; the yield on the investment is no longer attractive; or we are in need of cash. Because we invest only in marketable securities that are believed to be highly liquid and investment grade, we believe that the purchase, maturity or sale of our investments will have no material impact on our overall liquidity. However, in the third quarter of 2007, $7.2 million of our auction rate securities failed to sell at auction and we believe are temporarily not liquid. We believe these investments are at fair value because the securities have reset to the maximum interest rate available, compensating us for the non-liquidity. We have used cash to acquire businesses and technologies that enhance and expand our product offerings, and we anticipate that we will continue to do so in the future. The nature of these transactions makes it difficult to predict the amount and timing of such cash requirements.

Financing Activities

Our financing activities provided $0.8 million for the nine months ended September 30, 2007, resulting from proceeds of the exercises of employee stock options as well as payments made on capital lease obligations. Financing activities provided $49.9 million for the nine months ended October 1, 2006, primarily due to the completion of our secondary offering in which we raised $48.5 million of net proceeds. We have used, and continue to intend to use, the net proceeds for working capital and general corporate purposes, which may include the acquisition of businesses, products, product rights or technologies, strategic investments or purchases of common stock.

 

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We believe that our existing cash, cash equivalents and cash flows expected to be generated from future operations, if any, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our rate of revenue growth, our ability to develop future revenue streams, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. Although we are currently not a party to any agreement with respect to potential investments in, or acquisitions of, complementary businesses, products or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders. Additional debt would result in increased interest expenses and could result in covenants that would restrict our operations. We have not made arrangements to obtain additional financing, and there is no assurance that such financing, if required, will be available in amounts or on terms acceptable to us, if at all.

Contractual Commitments and Off-Balance Sheet Arrangements

We do not use off-balance-sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance-sheet arrangements such as special purpose entities and research and development arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance-sheet risks from unconsolidated entities.

We lease certain office facilities, equipment and software under non-cancelable operating leases. The following table summarizes our contractual obligations as of September 30, 2007, and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in millions):

 

     Payment due by period
     Total    Remainder
of 2007
   2008 and
2009
   2010 and
Thereafter

Operating lease payments

   $ 4.4    $ 0.4    $ 3.2    $ 0.8

Restructuring payments

     2.8      1.3      1.5      —  

Inventory purchase obligations

     7.4      7.4      —        —  

Access to technology

     2.8      0.4      2.4      —  

Minimum royalty obligation

     0.7      —        0.7      —  

Software development agreement

     0.7      0.5      0.2      —  
                           
   $ 18.8    $ 10.0    $ 8.0    $ 0.8
                           

For the purpose of this table, purchase obligations for the purchase of goods or services are defined as agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors within short time horizons. In addition, we have purchase orders that represent authorizations to purchase rather than binding agreements. We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements. Access to technology represents an agreement under which we have the right to use specific technology from a third party for a period of three years. Minimum royalty obligations represent minimum royalty payments with suppliers.

In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant, and we are unable to estimate the maximum potential impact of these indemnification provisions on our future consolidated results of operations.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, provides a framework for measuring fair value, and expands the disclosures required for fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require fair value measurements; it does not require any new fair value measurements. We are required to apply the provisions of SFAS No. 157 beginning in 2008. The adoption of SFAS No. 157 is not expected to have a material effect on our consolidated statements of financial position, operations, or cash flows.

In February 2007, the FASB issued SFAS No. 159, the Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which expands the standards under SFAS 157 to provide the one-time election (Fair Value Option) to measure financial instruments and certain other items at fair value and also includes an amendment of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. SFAS 159 will be effective for the Company beginning in 2008. The adoption of SFAS No. 159 is not expected to have a material effect on our consolidated statements of financial position, operations, or cash flows.

In June 2007, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force (“EITF”) Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. This issue provides that nonrefundable advance payments for goods or services that will be used or rendered for future research and development

 

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activities should be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed. EITF Issue No. 07-3 will be effective for the Company beginning in 2008. The adoption of this EITF is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

All market risk sensitive instruments were entered into for non-trading purposes. We do not use derivative financial instruments for speculative trading purposes. As of September 30, 2007, we did not hold derivative financial instruments.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal and meet liquidity needs, while maximizing yields and without significantly increasing risk. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer or type of investment. Our investments consist primarily of U.S. government notes and bonds, corporate notes and bonds and auction rate securities. All investments are carried at market value, which approximates cost.

As of September 30, 2007, we had cash, cash equivalents and short term investments totaling $99.3 million. These amounts were invested primarily in money market funds and short-term investments that are held for working capital purposes. We do not enter into investments for trading or speculative purposes. If the return on our cash equivalents and short-term investments were to change by one percent, the effect would be to increase/decrease investment income by approximately $0.3 million.

Foreign Currency Risk

Our revenue and cost, including subcontractor manufacturing expenses, are predominately denominated in U.S. dollars. An increase of the U.S. dollar relative to the currencies of the countries that our customers operate in would make our products more expensive to them and increase pricing pressure or reduce demand for our products. We also incur a portion of our expenses in currencies other than the U.S. dollar, including the Japanese yen, Korean won, Indian rupee, Singapore dollar and the Euro. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we feel our foreign currency exposure has increased, we may consider entering into hedging transactions to help mitigate that risk. We expect that our foreign currency exposure will increase as our operations in India and other countries expand.

 

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as required by Rules 13a-15(b) or 15d-15(b) of the Securities Exchange Act of 1934, as amended. Based on their evaluation, our certifying officers concluded that these disclosure controls and procedures were effective.

We believe that a system of internal controls, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and can be affected by limitations inherent in all internal controls systems including the realities that human judgment in decision-making can be faulty, that persons responsible for establishing controls need to consider their relative costs and benefits, that breakdowns can occur because of human failures such as simple error or mistake, and that controls can be circumvented by collusion of two or more people. Accordingly, we believe that our system of internal controls, while effective, can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

There was no change in our internal control over financial reporting during the quarter ended September 30, 2007, that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

 

Item 1. Legal Proceedings

In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, our directors, an executive officer and a former executive officer, as well as the lead underwriters for our initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint alleges certain material misrepresentations and omissions by us in connection with our initial public offering in September 2005 and the

 

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follow-on offering in March 2006 concerning our business and prospects, and seek unspecified damages. On June 25, 2007, we filed motions to dismiss the amended complaint; plaintiffs opposed the motions and the matter is pending a decision by the court. We cannot predict the likely outcome of this litigation, and an adverse result could have a material effect on our financial statements.

Additionally, from time to time we are a party to various legal proceedings and claims arising from the normal course of business activities. Based on current available information, we do not expect that the ultimate outcome of any currently pending unresolved matters, individually or in the aggregate, will have a material adverse effect on our results of operations, cash flows or financial position.

 

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this Quarterly Report on Form 10-Q, and in our other filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2006 and subsequent reports on Form 8-K, before deciding whether to invest in shares of our common stock. Additional risks and uncertainties not presently known to us may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on us, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock will likely decline and you may lose all or part of your investment.

Risks Related to Our Business

Our quarterly operating results, including revenue and expense levels, have fluctuated significantly over time and are likely to continue to do so, principally due to the nature of telecommunication carriers’ capital spending cycles as well as other factors. As a result, we may fail to meet or exceed our forecasts or the expectations of securities analysts or investors, which could cause our stock price to decline.

The telecommunications semiconductor industry is highly cyclical and subject to rapid change and, from time to time, has experienced significant downturns. As was widely reported in the first half of this decade, the telecommunications industry from time to time has experienced and may again experience a pronounced downturn. These downturns are characterized by decreases in product demand, excess inventories held by our customers – the original equipment manufacturers (“OEM’s”) – and their customers, the telecommunications service providers (also called “carriers”). To respond to these downturns, many carriers slow their capital expenditures, cancel or delay new developments, reduce their workforces and inventories and take a cautious approach to acquiring new equipment and technologies from OEMs,

As a result of the carriers slowing or ceasing their capital spending, periodically and usually without significant notice, carriers will reduce orders with OEMs for new equipment, and OEMs in turn will reduce orders for our products, which can adversely impact the quarterly demand for our products, even when deployment rates may be increasing. These factors have in the past, and could in the future cause substantial fluctuations in our revenue and in our operating results. Since we began shipping in volume in 2002, our quarterly revenue and operating results have varied significantly and are likely to continue to vary from quarter to quarter due to these industry cycles, which are not within our control. For example, in the first quarter of 2005, our revenue decreased by $6.2 million, or 33%, from the preceding quarter, but then increased by $7.0 million, or 57%, in the following quarter. In the fourth quarter of 2006, our revenue declined by $15.7 million, or 43%, from the third quarter of 2006. Quarterly fluctuations in revenue are characteristic of our industry. And given the concentration of our revenue among a few significant customers and given their buying patterns, we have experienced, and are likely to experience again, significant quarterly fluctuations of revenue.

Any future downturns may be severe and prolonged, and any failure of this industry or the broadband communications markets to fully recover from downturns could harm our business. The semiconductor industry also periodically experiences increased demand and production capacity constraints, which may affect our ability to ship products. Accordingly, our operating results may vary significantly as a result of the general conditions in the semiconductor or broadband communications industry, which could cause our stock price to decline.

In addition, our expenses are also subject to quarterly fluctuations resulting from factors including the costs related to new product releases. If our operating results do not meet the expectations of securities analysts or investors for any quarter or other reporting period, the market price of our common stock may decline. Fluctuations in our operating results may be due to a number of factors, including, but not limited to, changes in the mix of products we develop, acquire and sell as well as those identified throughout this “Risk Factors” section. As a result, you should not rely on quarter to quarter comparisons of our operating results as an indicator of future performance.

We have a history of losses, and future losses may cause the market price of our common stock to decline. We may not be able to reduce our expenses or generate sufficient revenue in the future to achieve or sustain profitability.

Since inception, we have only been profitable in the third and fourth quarter of 2005. We incurred significant net losses prior to such quarters, and we incurred losses in the past six quarters. We had sequential decreases in revenue in the third and fourth quarters of 2006, and we incurred a net loss of $29.2 million for the nine months ended September 30, 2007 and have an accumulated deficit of $138.6 million as of September 30, 2007. To achieve profitability again, we will need to generate and sustain higher revenue, while maintaining cost and expense levels appropriate and necessary for our business. In October 2007, we announced a business restructuring in which we decided to outsource our physical back-end layout function and in which a number of senior executives left the Company. We expect these actions to result in a $3.5 million reduction in our fiscal 2008 expenses. Because many of our expenses are fixed in the short term, or are incurred in advance of anticipated sales, we may not be able to continue to hold down our costs and expenses in a timely manner to offset any lower-than-forecasted revenue shortfall as we experienced in the fourth quarter of 2006. We may not be able to achieve profitability again, and even if we were able to attain profitability again, we may not be able to sustain profitability on a quarterly or an annual basis in the future.

 

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If demand for our semiconductor products declines or does not grow, we will be unable to increase or sustain our revenue; and our operating results will be harmed.

We currently expect the semiconductor products we have already announced to account for substantially all of our revenue for the foreseeable future. If we are unable to develop new products or to successfully integrate acquired products and technology to meet our customers’ demand in a timely manner, if demand for our semiconductors declines or fails to grow, or if the VDSLx, GPON or network processor markets do not materialize as expected, it would harm our business. The markets for our products are characterized by frequent introduction of new semiconductors, short product life cycles and significant price competition. If we or our OEM customers are unable to manage product transitions in a timely and cost-effective manner, our revenue would suffer. In addition, frequent technology changes and introduction of next generation products may result in inventory obsolescence, which would increase our cost of revenue and adversely affect our operating performance.

The average selling prices of our products are subject to rapid declines, which may harm our revenue and profitability.

The products we develop and sell are subject to rapid declines in average selling prices due to competitive pressures and business objectives, including lowering average selling prices in order to increase market share. We have lowered our prices significantly at times to gain market share, and we expect that we will reduce prices again in the future. Offering reduced prices to one customer could likely impact our average selling prices to all customers. Our financial results will suffer if we are unable to offset any future reductions in our average selling prices by increasing our sales volumes, or by reducing our cost and expenses or by developing new or enhanced products on a timely basis that bear higher selling prices.

Our product mix is subject to frequent and unexpected changes, which may impact our revenue and margin. (We define margin as revenue minus cost of revenue divided by revenue.)

Our product margins vary widely by product. As a result, a change in the sales mix of our products could have an impact on the forecasted revenue and margins for the quarter. In 2006, we acquired network processor products from Analog Devices, Inc. (“ADI”). These products are included in our Gateway product family and generally have lower margins as compared to our Access product family. Furthermore, the product margins within our Access product line can vary based on the type and performance of deployment being used as customers typically pay higher selling prices for higher performance. In Japan, we experienced a shift from our Access products to our Gateway products during 2006 as some carriers have partially shifted from building out the infrastructure to adding subscribers. This shift from higher to lower margin business could happen in other markets, depending upon what products carriers decide to deploy their networks or a competitive pricing situation. While we make estimates of what we believe the product mix will be in a given quarter, actual results can be materially different than our estimates.

Because we depend on a few significant customers for a substantial portion of our revenue, the loss of any of our key customers, our inability to continue to sell existing and new products to our key customers in significant quantities or our failure to attract new significant customers could adversely impact our revenue and harm our business.

We derive a substantial portion of our revenue from sales to a relatively small number of customers. As a result, the loss of any significant customer or a decline in business with any significant customer would materially and adversely affect our financial condition and results of operations. The following customers accounted for more than 10% of our revenue for any one of the periods indicated. We have indicated the OEM customer based on information that we receive at the time of ordering.

 

Our Direct Customer

   OEM Customer   Year Ended
January 1, 2006
    Year Ended
December 31, 2006
    Nine Months
Ended
September 30,
2007
 

NEC Corporation (USA)

   NEC Corporation (Magnus)   44 %   23 %   30 %

Altima

   Sumitomo Electric Industries, Ltd.   28 %   19 %   17 %

Sagem

   Sagem   —       23 %   21 %

Uniquest

   Various   24 %   22 %   12 %

A small group of OEM customers historically has accounted for a substantial portion of our revenue; the composition of this group has varied, and we expect will continue to vary, over time. Further, we expect that this small group of customers will continue to account for a substantial portion of our revenue for the remainder of 2007, and in the foreseeable future. Accordingly, our future operating results will continue to depend on the success of our largest OEM customers and on our ability to sell existing and new products to these customers in significant quantities. Demand for our semiconductor products is based on carrier demand for our OEM customers’ systems products. Accordingly, a reduction in growth of carrier deployment of product that use our semiconductors would adversely affect our product sales and business.

 

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In addition, our relationships with some of our larger OEM customers may also deter other potential customers who compete with these customers from buying our products. To attract new customers or retain existing OEM customers, we have offered and may continue to offer certain customers favorable prices on our products. If these prices are lower than the prices paid by other existing OEM customers, we may have to offer the same lower prices to certain of these customers. In that event, our average selling prices would decline. The loss of a key customer, a reduction in sales to any major customer, or our inability to attract new significant customers in the absence of any offsetting sales would harm our business.

We have historically derived a substantial amount of our revenue from Asia; and with the NPA acquisition, a majority of our network processing revenue comes from a single customer in Europe. If we fail to diversify the geographic sources and customer base of our revenue in the future, our operating results could be harmed.

A substantial portion of our revenue is derived from sales into Japan, Korea and France; and our revenue has been heavily dependent on market growth in these countries. As a result, our sales are subject to economic downturns, decrease in demand and overall negative market conditions in a very few number of specific economies. For instance, a sustained slow down in growth of fiber extension over copper and broadband over copper subscribers in Asia has cause our revenue to decline, and may prevent our revenue from returning to historical levels. While part of our strategy is to continue to diversify the geographic sources and customer base of our revenue, our failure to successfully penetrate markets other than those served by our existing customers, and diversify our customer base could harm our business and operating results.

We recently took steps to outsource our physical back-end semiconductor design process to a third-party. If this transition is unsuccessful we could delay release of upcoming products or incur more costs related to the design and manufacturing of our products.

In September 2007 we decided to outsource our physical back-end design process resulting in the impairment and write-off of $2.9 million in software design tools and the subsequent termination of approximately 10 employees. Loss of their knowledge and expertise may harm our development efforts, and transition to a third-party could result in production delays and increased costs. We are in the process of identifying a third-party to handle our back-end semiconductor design to perform this function for us. Securing a third-party could take longer than expected and could delay or prevent the release of future products. The number of third-parties that can provide this service is relatively small, and failure to identify one with adequate resources could result in greater costs than if we kept the process in-house. Furthermore, outsourcing could result in longer design cycles and an inefficient semiconductor design layout, resulting in an increase in manufacturing costs and a decrease in the performance of our products.

We have recently experienced a turnover in several senior management positions, and we may be unable to attract, retain and motivate key senior management and technical personnel, which could harm our development of technology and ability to be competitive.

Our new Chief Executive Officer, Michael Ricci, joined the company in early June 2007. In addition, in June and July of 2007, we hired a Vice President and General Counsel, a new Vice President of Operations and a new Vice President of Engineering. Further, as required, we seek out highly-qualified candidates to fill positions throughout our business. We will continue to examine ways to improve the company’s processes, productivity and results.

Our future success depends to a significant extent upon the continued service of our senior executives and key technical personnel as well as the integration of new senior executives. We do not have employment agreements with any of these executives or any other key employees that govern the length of their service. Changes in the services of senior management or technical personnel could impact our customer relationships, employee morale, our ability to operate in compliance with existing internal controls and regulations and harm our business. For example, in November 2006, we reduced the number of employees and contractors in our workforce by approximately 30 people. Additionally, in September 2007, we decided to reduce the number of employees by approximately 15 people, including several senior executives. These reductions were principally in our engineering departments and have resulted in reallocations of employee duties. Workforce reductions and job reassignments could negatively affect employee morale and make it difficult to motivate and retain the remaining employees and contractors, which would affect our ability to deliver our products in a timely fashion and otherwise negatively affect our business.

Furthermore, our future success depends on our ability to continue to attract, retain and motivate other senior management and qualified technical personnel, particularly software engineers, digital circuit designers, mixed-signal circuit designers and systems and algorithms engineers. Competition for these employees is intense. Stock options, restricted stock units and other equity incentives generally comprise a significant portion of our compensation packages for all employees, and the expected volatility in the price of our common stock may make it more difficult for us to attract and retain key employees, which could harm our ability to provide technologically competitive products.

Because of the rapid technological development in our industry and the intense competition we face, our products tend to become outmoded or obsolete in a relatively short period of time, which requires us to provide frequent updates and/or replacements to existing products. If we do not successfully manage the transition process to next generation semiconductor products, our operating results may be harmed.

Our industry is characterized by rapid technological innovation and intense competition. Accordingly, our success depends in part on our ability to develop next generation semiconductor products in a timely and cost-effective manner. The development of new semiconductor products is expensive, complex and time consuming. If we do not rapidly develop our next generation semiconductor products ahead of our competitors, we may lose both existing and potential customers to our competitors. Further, if a competitor develops a new, less expensive

 

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product using a different technological approach to delivering broadband services over existing networks, our products would no longer be competitive. Conversely, even if we are successful in rapidly developing new semiconductor products ahead of our competitors and we do not cost-effectively manage our inventory levels of existing products when making the transition to the new semiconductor products, our financial results could be negatively affected by high levels of obsolete inventory. If any of the foregoing were to occur, then our operating results would be harmed.

We rely on third-party technologies for the development of our products; and our inability to use such technologies in the future would harm our ability to remain competitive.

We rely on third parties for technologies that are integrated into some of our products, including our recently announced GPON product development project, as well as memory cells, input/output cells and core processor logic. If we are unable to continue to use or license these technologies on reasonable terms, or if these technologies fail to operate properly, we may not be able to secure alternatives in a timely manner and our ability to remain competitive would be harmed. Failure to use the technologies we have purchased could also result in unfavorable impairment costs. In addition, if we are unable to successfully license technology from third parties to develop future products, we may not be able to develop such products in a timely manner or at all.

We are a fabless semiconductor company and may rely on one wafer foundry and one assembly and test subcontractor to manufacture, package and test each of our products, and our failure to secure and maintain sufficient capacity with these subcontractors could impair our relationships with customers and decrease sales, which would negatively impact our market share and operating results.

We are a fabless semiconductor company in that we do not own or operate a fabrication or manufacturing facility. Currently, five wafer foundries and three outside factory subcontractors, located in Austria, Israel, Korea, Malaysia, Singapore, Taiwan, China and the United States manufacture, assemble and test all of our semiconductor devices in current production. While we work with multiple suppliers, only one foundry and one assembly and test subcontractor may be used for a single product. Accordingly, we are greatly dependent on a limited number of suppliers to deliver quality products on time.

In past periods of high demand in the semiconductor market, we have experienced delays in meeting our capacity demand and as a result were unable to deliver products to our customers on a timely basis. In addition, we have experienced similar delays due to technical and quality control problems. Furthermore, our costs for manufacturing services or components have increased from time to time without significant notice. In the future, if any of these events occur, or if the facilities of any of our subcontractors suffer any damage, power outages, financial difficulties or any other disruption due to natural disasters, terrorist acts or otherwise, we may be unable to meet our customer demand on a timely basis, or at all; and we may be required to incur additional costs and may need to successfully qualify an alternative facility in order to not disrupt our business. We typically require several months or more to qualify a new facility or process before we can begin shipping products. If we cannot accomplish this qualification in a timely manner, we would experience a significant interruption in supply of the affected products which could in turn cause our costs of revenue to increase and our overall revenue to decrease. If we are unable to secure sufficient capacity at our subcontractors’ existing facilities, or in the event of a closure or significant delay at any of these facilities, our relationships with our customers would be harmed and our market share and operating results would suffer as a result. In addition, we do not have formal pricing agreements with our subcontractors regarding the pricing for the products and services that they provide us. If their pricing for the products and services they provide increases and we are unable to pass along such increases to our OEM customers, our operating results would be adversely affected.

In the event we seek to use new wafer foundries to manufacture a portion of our semiconductor products, we may not be able to bring the new foundries on-line rapidly enough and may not achieve anticipated cost reductions.

As indicated, we use five independent wafer foundries to manufacture all of our semiconductor products, which expose us to risks of delay, increased costs and customer dissatisfaction in the event that any of these foundries were unable to provide us with our semiconductor requirements. Particularly during times when semiconductor manufacturing capacity is limited, we may seek to qualify additional wafer foundries to meet our requirements. In order to bring these new foundries on-line, our customers may need to qualify product from the new facility, which could take several months or more. Once qualified, these new foundries would then require an additional number of months to actually begin producing semiconductors to meet our needs, by which time the temporary requirement for additional capacity may have passed or the opportunities we previously identified may have been lost to our competitors. Furthermore, even if these new foundries offer better pricing than our existing manufacturers, if they prove to be less reliable than our existing manufacturers, we would not achieve some or all of our anticipated cost reductions.

When demand for manufacturing capacity is high, we may take various actions to try to secure sufficient capacity, which may be costly and negatively impact our operating results.

The ability of each of our subcontractors’ manufacturing facilities to provide us with semiconductors is limited by its available capacity and existing obligations. Although we have purchase order commitments to supply specified levels of products to our OEM customers, we do not have a guaranteed level of production capacity from any of our subcontractors’ facilities that we depend on to produce our semiconductors. Facility capacity may not be available when we need it or at reasonable prices. We place our orders on the basis of our OEM customers’ purchase orders or our forecast of customer demand, and our subcontractors may not be able to meet our requirements in a timely manner. For example, in the second half of 2005 and in the first half of 2006, general market conditions in the semiconductor industry resulted in a significant increase in demand at these facilities. The demand for some of our OEM customers’ products increased significantly, and we were

 

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asked to produce significantly higher quantities than in the past and to deliver on short notice. In addition, our subcontractors have also allocated capacity to the production of other companies’ products and reduced deliveries to us on short notice. It is possible that our subcontractors’ other customers that are larger and better financed than we are, or that have long-term agreements with our subcontractors, may have induced our subcontractors to reallocate capacity to them. If this reallocation were to occur again, it would impair our ability to deliver products on a timely basis.

In order to secure sufficient manufacturing facility capacity when demand is high and mitigate the risks described in the foregoing paragraphs, we may enter into various arrangements with subcontractors that could be costly and harm our operating results, including:

 

   

option payments or other prepayments to a subcontractor;

 

   

nonrefundable deposits with or loans to subcontractors in exchange for capacity commitments;

 

   

contracts that commit us to purchase specified quantities of components over extended periods;

 

   

purchase of testing equipment for specific use at our subcontractors’ facilities;

 

   

issuance of our equity securities to a subcontractor; and

 

   

other contractual relationships with subcontractors.

We may not be able to make any such arrangements in a timely fashion or at all, and any arrangements may be costly, reduce our financial flexibility and not be on terms favorable to us. Moreover, if we are able to secure facility capacity, we may be obligated to use all of that capacity or incur penalties. These penalties and obligations may be expensive and require significant capital and could harm our business.

We attempt to mitigate the capacity limitations of specific wafer foundries by licensing the technologies used to build our products in a manner that allows us to have “foundry mobility,” that is, the ability to have different foundries manufacture the same product; if the effort to achieve foundry mobility is not successful, our results could suffer due to capacity limitations of our foundries.

When we develop our products, we use design and development tools licensed from third parties. Those tools are frequently licensed to be used only at a specific foundry. One method for reducing the potential risk of manufacturing constraints is to license those tools so that we may use them at multiple foundries; this practice is referred to as “foundry mobility.” To the extent that we are able to achieve foundry mobility, we may be better able to mitigate the negative impact arising when a foundry has reduced ability to meet our manufacturing requirements. If we are unable to use multiple foundries for a product in high demand due to a lack of foundry mobility, and that limited our ability to ship product in a specific period, our results would be negatively affected.

If our subcontractors’ manufacturing facilities do not achieve satisfactory quality or yields, our relationships with our customers and our reputation will be harmed, our revenue and operating results could decline, and our cost of revenue as a percentage of revenue could increase.

Manufacturing defects may not be detected by the testing process performed by our subcontractors. If defects are discovered after we have shipped our products, we have and could continue to experience warranty and consequential damages claims from our customers. In January 2007, a significant customer notified us that they were experiencing a high defect rate on a certain product that was manufactured and shipped in the last month of fiscal 2006. On February 8, 2007, the customer submitted a claim seeking replacement parts and specified damages. We evaluated the merits of the claim, concluded it was in our best interests to resolve the matter, and on February 26, 2007, entered into a settlement agreement releasing us of all liabilities associated with this claim in exchange for a payment and providing replacement parts. The settlement was recorded as an offset to revenue and as accrued rebates within accrued liabilities in the fourth quarter of 2006. Such claims as this one or others may have a significant adverse impact on our revenue and operating results. Furthermore, if we are unable to deliver quality products, our reputation would be harmed, which could result in the loss of, future orders and business with these OEMs. If any of these adverse risks are realized and we are not able to offset the lost opportunities, our revenue, margins and operating results would decline.

The fabrication of semiconductors is a complex and technically demanding process. Minor deviations in the manufacturing process can cause substantial decreases in yields; and in some cases, cause production to be stopped or suspended. We have experienced difficulties in achieving acceptable yields on some of our products, particularly with new products, which frequently involve newer manufacturing processes and smaller geometry features than previous generations. Maintaining high numbers of shippable die per wafer is critical to our operating results, as decreased yields can result in higher per unit cost, shipment delays and increased expenses associated with resolving yield problems. Although we work closely with our subcontractors to minimize the likelihood of reduced manufacturing yields, their facilities have from time to time experienced lower than anticipated manufacturing yields that have resulted in our inability to meet our customer demand. For instance, in the third quarter of 2006, we were unable to fulfill a certain amount of our customers’ orders due to difficulties in attaining acceptable yields on one of our products. While we solved the manufacturing process issue in the fourth quarter of 2006, we cannot assure you that we will be successful in improving yields on any future product or in correcting manufacturing problems with our subcontractors.

It is common for yields in semiconductor fabrication facilities to decrease in times of high demand or due to poor workmanship or operational problems at these facilities. When these events occur, especially simultaneously, as happens from time to time, we may be unable to supply our customers’ demand. Many of these problems are difficult to detect at an early stage of the manufacturing process and, regardless

 

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of when the problems are detected, they may be time consuming and expensive to correct. In addition, because we purchase wafers, our exposure to low wafer yields from our subcontractors’ wafer foundries are increased. Poor yields from the wafer foundries or defects, integration issues or other performance problems in our products could cause us significant customer relations and business reputation problems, or force us to sell our products at lower gross margins and therefore harm our financial results. Conversely, unexpected yield improvements could result in us holding excess inventory that would also increase our product cost and negatively impact our profitability.

We base orders for inventory on our forecasts of our OEM customers’ demand and if our forecasts are inaccurate, our financial condition and liquidity would suffer.

We place orders with our suppliers based on our forecasts of our OEM customers’ demand. Our forecasts are based on multiple assumptions, each of which may introduce errors into our estimates. In the past, when the demand for our OEM customers’ products increased significantly, we were not able to meet demand on a timely basis, and we expended a significant amount of time working with our customers to allocate limited supply and maintain positive customer relations. If we underestimate customer demand, we may forego revenue opportunities, lose market share and damage our customer relationships. Conversely, if we overestimate customer demand, we may allocate resources to manufacturing products that we may not be able to sell. As a result, we would have excess or obsolete inventory, resulting in a decline in the value of our inventory, which would increase our cost of revenue and create a drain on our liquidity. Our failure to accurately manage inventory against demand would adversely affect our financial results.

To remain competitive, we need to continue to reduce the cost of our semiconductor chips, which includes migrating to smaller geometrical process, and our failure to do so may harm our business.

We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometrical processes, which are measured in microns or nanometers. We have designed our products to be manufactured in 0.8 micron, 0.25 micron, 0.18 micron, 0.13 micron, 0.09 micron (or 90 nanometer) and 0.065 micron (or 65 nanometer) geometrical processes. We are currently migrating some of our products to an even smaller geometrical process technology, and over time, we are likely to migrate to even smaller geometries. The smaller geometry generally reduces our production and packaging costs, which may enable us to be competitive in our pricing. The transition to smaller geometries requires us to work with our subcontractors to modify the manufacturing processes for our products, to develop new and more complex quality assurance tests and to redesign some products. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased product costs and expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes, all of which could harm our relationships with our customers, and our failure to do so would impact our ability to provide competitive prices to our customers, which would have a negative impact on our sales. Additionally, upfront expenses associated with smaller geometry process technologies such as for masks and tooling can be significantly higher than those for the processes that we currently use, and our migration to these newer process technologies can result in significantly higher research and development expenses.

The complexity of our products could result in unforeseen delays or expenses and in undetected defects or bugs, which could damage our reputation with current or prospective customers and adversely affect the market acceptance of new products.

Highly complex products such as those that we offer frequently contain defects and bugs, particularly when they are first introduced or as new versions are released. In the past, we have experienced, and may in the future experience, defects and bugs in our products. These defects and bugs may originate in third party intellectual property incorporated into our products as well as in technology designed by Ikanos’ engineers. If any of our products contains defects or bugs, or have reliability, quality or compatibility problems, our reputation may be damaged; and our OEM customers may be reluctant to buy our products, which could harm our ability to retain existing customers and attract new customers. In addition, these defects or bugs could interrupt or delay sales or shipment of our products to our customers.

We face intense competition in the semiconductor industry and the broadband communications markets, which could reduce our market share and negatively impact our revenue.

The semiconductor industry and the broadband communications markets are intensely competitive. We currently compete or expect to compete with, among others, Broadcom Corporation, Centillium Communications, Inc., Conexant Systems, Inc., Infineon Technologies A.G., Marvell Technology Group Ltd., Texas Instruments Incorporated, Thomson S.A., TrendChip Technologies Corp. and Aware, Inc, which companies, we believe, have experience in VDSLx, or VDSL-like, technology. We also expect to compete with, among others, Freescale Semiconductor, Inc., Intel Corporation, Technovas, Broadlight, Cavium Networks, Marvell Technology Group Ltd., PMC-Sierra, Inc. and Realtek Semiconductor Corp in the PON and network processing markets. We expect competition to continue to increase. Competition has resulted and may continue to result in declining average selling prices for our products and market share.

We consider other companies that have access to Discrete Multi Tone (“DMT”) technology as potential competitors in the future, and we also may face competition from newly established competitors, suppliers of products based on new or emerging technologies and customers who choose to develop their own semiconductors. To remain competitive, we need to provide products that are designed to meet our customers’ needs. Our products must:

 

   

achieve optimal product performance;

 

   

comply with industry standards;

 

   

be cost-effective for our customers’ use in their systems;

 

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meet functional specifications;

 

   

be introduced timely to the market; and

 

   

be supported by a high-level of customer service and support.

Many of our competitors operate their own fabrication facilities or have stronger manufacturing partner relationships than we have. In addition, many of our competitors have extensive technology libraries that could enable them to incorporate fiber-fast broadband or network processing technologies into a more attractive product line than ours. Many of them also have longer operating histories, greater name recognition, larger customer bases, and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. In addition, current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Existing or new competitors may also develop alternative technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of semiconductor integration or lower cost. We cannot assure you that we will be able to compete successfully against current or new competitors, in which case we may lose market share in our existing markets and our revenue may fail to increase or may decline.

Other data transmission technologies and network processing technologies may compete effectively with the carrier services addressed by our products, which could adversely affect our revenue and business.

Our revenue is dependent on the increase in demand for carrier services that use VDSLx broadband technology and integrated residential gateways. Besides VDSLx and other DMT-based technologies, carriers can decide to deploy passive optical networks, which is some times also referred to as PON or fiber. In this case, fiber is used to connect directly to the residence instead of using the existing copper phone line. As such, if a carrier decides to deploy fiber-to-the-home, our VDSL solutions are not required. For example, a major carrier in Korea announced its intention to use more fiber-to-the-home deployments in the future. Such deployments of fiber may be in lieu of VDSLx solutions. If more carriers decide to use fiber-to-the-home deployments, it could harm our business.

Furthermore, residential gateways compete against a variety of different data distribution technologies, including Ethernet routers, set-top boxes provided by cable and satellite providers, wireless (WiMax) and emerging power line and multimedia over coax alliance technologies. If any of these competing technologies proves to be more reliable, faster or less expensive than, or has any other advantages over the Fiber Fast broadband technologies we provide, the demand for our products may decrease and our business would be harmed.

If we are unable to develop, introduce or to achieve market acceptance of our new semiconductor products, our operating results would be adversely affected.

Our future success depends on our ability to develop new semiconductor products and transition to new products, introduce these products in a cost-effective and timely manner and convince OEMs to select our products for design into their new systems. Our historical quarterly results have been, and we expect that our future results will continue to be, dependent on the introduction of a relatively small number of new products and the timely completion and delivery of those products to customers. The development of new semiconductor products is complex, and from time to time we have experienced delays in completing the development and introduction of new products. We have in the past invested substantial resources in emerging technologies that did not achieve the market acceptance that we had expected. Our ability to develop and deliver new semiconductor products successfully will depend on various factors, including our ability to:

 

   

successfully integrate certain technologies acquired in acquisitions into our product lines;

 

   

accurately predict market requirements and evolving industry standards;

 

   

accurately define new semiconductor products;

 

   

timely complete and introduce new product designs or features;

 

   

timely qualify and obtain industry interoperability certification of our products and the equipment into which our products will be incorporated;

 

   

ensure that our subcontractors have sufficient foundry capacity and packaging materials and achieve acceptable manufacturing yields;

 

   

shift our products to smaller geometry process technologies to achieve lower cost and higher levels of design integration; and

 

   

gain market acceptance of our products and our OEM customers’ products.

If we are unable to develop and introduce new semiconductor products successfully and in a cost-effective and timely manner, we will not be able to attract new customers or retain our existing customers, which would harm our business.

 

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Our success is dependent upon achieving design wins into commercially successful OEM systems.

Our products are generally incorporated into our OEMs customers’ systems at the design stage. As a result, we rely on OEMs to select our products to be designed into their systems, which we refer to as a “design win.” We often incur significant expenditures over multiple fiscal quarters in attempting to obtain a design win without any assurance that an OEM will select our product for design into its own system. Additionally, in some instances, we are dependent on third parties to obtain or provide information that we need to achieve a design win. Some of these third parties may not supply this information to us on a timely basis, if at all. Furthermore, even if an OEM designs one of our products into its system offering, we cannot be assured that its equipment will be commercially successful or that we will receive any orders and, accordingly, revenue as a result of that design win. Our OEM customers are typically not obligated to purchase our products and can choose at any time to stop using our products if their own systems are not commercially successful, if they decide to pursue other systems strategies, or for any other reason. If we are unable to achieve design wins or if our OEM customers’ systems incorporating our products are not commercially successful, our revenue would suffer.

Acquisitions, strategic partnerships, joint ventures or investments may impair our capital and equity resources, divert our management’s attention or otherwise negatively impact our operating results.

We intend to continue to actively pursue acquisitions, strategic partnerships and joint ventures that we believe may allow us to complement our growth strategy, increase market share in our current markets and expand into adjacent markets, broaden our technology and intellectual property and strengthen our relationships with carriers and OEMs. For example, in 2006, we completed the NPA and Doradus acquisitions. These transactions consumed significant management attention, added to our expenses and used $34.9 million in cash. Any future acquisition, partnership, joint venture or investment may require that we pay significant cash, issue stock, thereby diluting existing stockholders, or incur substantial debt. Acquisitions, partnerships or joint ventures may also require significant managerial attention, which may divert our focus. These capital, equity and managerial commitments may impair the operation of our business. Furthermore, acquired businesses may not be effectively integrated, may be unable to maintain key pre-acquisition business relationships, may result in the loss of key personnel, may contribute to increased fixed costs and may expose us to unanticipated liabilities and otherwise harm our operating results.

Our products include a significant amount of firmware. If we are unable to deliver the firmware in a timely manner, we may have to delay revenue recognition at the end of a quarter, which could lead to significant unplanned fluctuations in our quarterly revenue. As a result, we may fail to meet or exceed our forecasts or the expectations of securities analysts or investors, which could cause our stock price to decline.

In connection with new product introductions in a given market, we release production quality code to our OEM customers. This firmware is required for our products to function as intended. If the production-ready firmware is not released in a timely manner, we may have to defer all revenue related to the semiconductors that we may have already shipped during the quarter, and therefore, cause us to miss our revenue guidance. In addition, a customer may demand a specific future software feature as part of its order. As such, we may have to delay recognition on some or all of our revenue related to that customer’s order until the future software feature is delivered. Such delays or deferrals in revenue recognition could lead to significant fluctuations in our quarterly revenue and operating results and cause us to fail to meet or exceed our quarterly revenue guidance.

We rely on third-party sales representatives to assist in selling our products, and the failure of these representatives to perform as expected could reduce our future sales.

We sell our products to some of our OEM customers through third-party sales representatives. Our relationships with some of our third-party sales representatives have been established within the last three years, most recently in China and Taiwan, and we are unable to predict the extent to which our third-party sales representatives will be successful in marketing and selling our products. Moreover, many of our third-party sales representatives also market and sell competing products. Our third-party sales representatives may terminate their relationships with us at any time, or with short notice. Our future performance will also depend, in part, on our ability to attract additional third-party sales representatives that will be able to market and support our products effectively, especially in markets in which we have not previously distributed our products. If we cannot retain our current third-party sales representatives and recruit additional or replacement third-party sales representatives, our revenue and operating results could be harmed.

Rapidly changing standards and regulations could make our products obsolete, which would cause our revenue and operating results to suffer.

We design our products to conform to regulations established by governments and to standards set by industry standards bodies worldwide such as The American National Standards Institute and The Committee T1E1.4 in North America, European Telecommunications Standards Institute in Europe and ITU-T and the Institute of Electrical and Electronics Engineers, Inc. Because our products are designed to conform to current specific industry standards, if competing standards emerge that are preferred by our customers, we would have to make significant expenditures to develop new products. If our customers adopt new or competing industry standards with which our products are not compatible, or the industry groups adopt standards or governments issue regulations with which our products are not compatible, our existing products would become less desirable to our customers and our revenue and operating results would suffer.

 

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If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenue or increase our cost.

Our success will depend, in part, on our ability to protect our intellectual property. We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. With the exception of a limited number of foreign trademark registrations, we do not currently have any applications on file in any foreign jurisdictions with respect to our intellectual property notwithstanding the fact nearly all of our revenue is generated outside of the United States. Our pending patent applications may not result in issued patents, and our existing and future patents may not be sufficiently broad to protect our proprietary technologies or may be held invalid or unenforceable in court. While we are not currently aware of misappropriation of our existing technology, policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where we have not applied for patent protections and, even if such protections were available, the laws may not protect our proprietary rights as fully as United States law. The patents we have obtained or licensed, or may obtain or license in the future, may not be adequate to protect our proprietary rights. Our competitors may independently develop or may have already developed technology similar to ours, duplicate our products or design around any patents issued to us or our other intellectual property. In addition, we have been, and may be, required to license our patents as a result of our participation in various standards organizations. If competitors appropriate our technology and we are not adequately protected, our competitive position would be harmed, our legal costs would increase and our revenue would be harmed.

Third-party claims of infringement or other claims against us could adversely affect our ability to market our products, require us to redesign our products or seek licenses from third parties, and harm our business. In addition, any litigation required to defend such claims could result in significant expenses and diversion of our resources.

Companies in the semiconductor industry often aggressively protect and pursue their intellectual property rights. From time to time, we receive, and are likely to continue to receive in the future, notices that claim our products infringe upon other parties’ proprietary rights. While we do not believe that we are currently infringing on the proprietary rights of third parties, we may in the future be engaged in litigation with parties who claim that we have infringed their patents or misappropriated or misused their trade secrets or who may seek to invalidate one or more of our patents, and it is possible that we would not prevail in any future lawsuits. An adverse determination in any of these types of claims could prevent us from manufacturing or selling some of our products could increase our costs of products and could expose us to significant liability. Any of these claims could harm our business. For example, in a patent or trade secret action, a court could issue a preliminary or permanent injunction that would require us to withdraw or recall certain products from the market or redesign certain products offered for sale or that are under development. In addition, we may be liable for damages for past infringement and royalties for future use of the technology and we may be liable for treble damages if infringement is found to have been willful. Even if claims against us are not valid or successfully asserted, these claims could result in significant costs and a diversion of management and personnel resources to defend.

Any potential dispute involving our patents or other intellectual property could also include our manufacturing subcontractors and OEM customers and/or carriers using our products, which could trigger our indemnification obligations to them and result in substantial expense to us.

In any potential dispute involving our patents or other intellectual property, our manufacturing subcontractors and OEM customers could also become the target of litigation. Because we often indemnify our customers for intellectual property claims made against them for products incorporating our technology, any litigation could trigger technical support and indemnification obligations in some of our license agreements, which could result in substantial expenses such as increased legal expenses, damages for past infringement or royalties for future use. From time to time, we receive notices that customers have received potential infringement notices from third parties. For instance, in the fourth quarter of 2006, an OEM customer informed us of a potential indemnity claim against our technology. While we have not incurred any indemnification expenses as a result of notices received to date, any future indemnity claim could adversely affect our relationships with our OEM customers and result in substantial costs to us.

Our products typically have lengthy sales cycles, which may cause our operating results to fluctuate and result in volatility in the price of our common stock. An OEM customer or a carrier may decide to cancel, delay or change its product plans, which could cause us to lose or delay anticipated sales.

After we have delivered a product to an OEM customer, the OEM will usually test and evaluate our product with its carrier customer prior to the OEM completing the design of its own equipment that will incorporate our product. Our OEM customers and the carriers may take several months to test, evaluate and adopt our product and several additional months to begin volume production of equipment that incorporates our product. This entire process can take from six months to over a year to complete. Due to this lengthy sales cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring these expenditures and investments. Even if an OEM customer selects our product to incorporate into its equipment, we have no assurances that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increases the risk that an OEM customer or carrier will decide to cancel or change its product plans. From time to time, we have experienced changes and cancellations in the purchase plans of our OEM customers. A cancellation or change in plans by an OEM customer or carrier could cause us to not achieve anticipated revenue and result in volatility of the price of our common stock. In addition, our anticipated sales could be lost or substantially reduced if a significant OEM customer or carrier reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products.

 

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Changes in current or future laws or regulations or the imposition of new laws or regulations by federal or state agencies or foreign governments could impede the sale of our products or otherwise harm our business.

The effects of regulation on our customers or the industries in which they operate may materially and adversely impact our business. For example, the Ministry of Internal Affairs and Communications in Japan, the Ministry of Communications and Information in Korea, the Federal Communications Commission (FCC) in the United States, and various national and regulatory agencies, as well as the European Commission in the European Union have broad jurisdiction over our target markets. Although the laws and regulations of these and other federal or state agencies may not be directly applicable to our products, they do apply to much of the equipment into which our products are incorporated. Governmental regulatory agencies worldwide may affect the ability of telephone companies to offer certain services to their customers or other aspects of their business, which may in turn impede sales of our products.

Recent changes to environmental laws and regulations applicable to manufacturers of electrical and electronic equipment are causing us to redesign our products, and may result in increases to our costs and greater exposure to liability.

The implementation of new environmental regulatory legal requirements, such as lead free initiatives, impacts our product designs and manufacturing processes. The impact of such regulations on our product designs and manufacturing processes could affect the timing of compliant product introductions as well as their commercial success. For example, the European Union banned the use of lead and other heavy metals in electrical and electronic equipment after July 1, 2006. As a result, some of our customers selling products in Europe are demanding product from component manufacturers that do not contain these banned substances. Because most of our existing assembly processes (as well as those of most other manufacturers) utilized a tin-lead alloy as a soldering material in the manufacturing process, we redesigned many of our products to meet customer demand. In January 2007, a customer could not get a certain number of lead free semiconductors to properly bond on the printed circuit board. We believe the lead-free substrates may have contributed to the bonding problem. In addition, given the limited experience and knowledge with the materials and processes used to manufacture lead-free parts, we may incur quality issues or production delays. Furthermore, the products that we manufacture that comply with the new regulatory standards may not perform as well as our current products. Moreover, if we are unable to successfully and timely redesign existing products and introduce new products that meet the standards set by environmental regulation and our customers, sales of our products could decline, which could materially adversely affect our business, financial condition and results of operations.

Compliance with the requirements imposed by Section 404 of the Sarbanes-Oxley Act could harm our operating results, our ability to operate our business and our investors’ view of us.

If we fail to maintain the adequacy of our internal controls, as standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of Sarbanes-Oxley. There is a risk that neither we, nor our independent registered public accounting firm, will be able to conclude that our internal controls over financial reporting are effective as required by Section 404 of Sarbanes-Oxley. In addition, during the course of our testing we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by Sarbanes-Oxley for compliance with the requirements of Section 404. Effective internal controls, particularly those related to revenue recognition, valuation of inventory and warranty provisions, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock could drop significantly.

We are highly dependent on manufacturing, development and sales activities outside of the United States; and as our international manufacturing, development and sales operations expand, we will be increasingly exposed to various legal, business, political and economic risks associated with our international operations.

We currently obtain substantially all of our manufacturing, assembly and testing services from suppliers and subcontractors located outside the United States, and have a significant portion of our research and development team located in Bangalore and Hyderabad, India. In addition, 94% of our revenue for the nine months ended September 30, 2007 and 96% of our revenue for the year ended December 31, 2006 was derived from sales to customers outside the United States. We have expanded our international business activities and may open other design and operational centers abroad. International operations are subject to many other inherent risks, including but not limited to:

 

   

political, social and economic instability, including war and terrorist acts;

 

   

exposure to different legal standards, particularly with respect to intellectual property;

 

   

natural disasters and public health emergencies;

 

   

trade and travel restrictions;

 

   

the imposition of governmental controls and restrictions or unexpected changes in regulatory requirements;

 

   

burdens of complying with a variety of foreign laws;

 

   

import and export license requirements and restrictions of the United States and each other country in which we operate;

 

   

foreign technical standards;

 

   

changes in tariffs;

 

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difficulties in staffing and managing international operations;

 

   

fluctuations in currency exchange rates;

 

   

difficulties in collecting receivables from foreign entities or delayed revenue recognition; and

 

   

potentially adverse tax consequences.

Because we are currently substantially dependent on our foreign sales, research and development and operations, any of the factors described above could significantly harm our ability to produce quality products in a timely and cost effective manner, and increase or maintain our foreign sales.

Fluctuations in exchange rates between and among the Japanese yen, the Korean won, the Indian rupee, the U.S. dollar, the Singapore dollar and the Euro, as well as other currencies in which we do business, may adversely affect our operating results.

We transact business internationally. As a result, we may experience foreign exchange gains or losses due to the volatility of other currencies compared to the U.S. dollar. Our sales have been historically denominated in U.S. dollars and an increase in the U.S. dollar relative to the currencies of the countries that our customers operate in could materially affect our Asian and European customers’ demand for our products, thereby forcing them to reduce their orders, which would adversely affect our business. We incur a portion of our expenses in currencies other than the U.S. dollar, including the Japanese yen, Korean won, Indian rupee, Singapore dollar and the Euro. As we report our results in U.S. dollars, the difference in exchange rates in one period compared to another directly impacts period to period comparisons of our operating results. Furthermore, currency exchange rates have been especially volatile in the recent past and these currency fluctuations may make it difficult for us to predict and/or provide guidance on our results.

Currently, we have not implemented any strategies to mitigate risks related to the impact of fluctuations in currency exchange rates. Even if we were to implement hedging strategies, not every exposure is or can be hedged, and, where hedges are put in place based on expected foreign exchange exposure, they are based on forecasts which may vary or which may later prove to have been inaccurate. Failure to hedge successfully or anticipate currency risks properly could adversely affect our operating results. We cannot predict future currency exchange rate changes.

Several of the facilities that manufacture our products, most of our OEM customers and the carriers they serve, and our California facility are located in regions that are subject to earthquakes and other natural disasters.

Several of our subcontractors’ facilities that manufacture, assemble and test our products, and one of our subcontractor’s wafer foundries, are located in Taiwan, Singapore and Malaysia. Our customers are currently primarily located in Japan and Korea. The Asia-Pacific region has experienced significant earthquakes and other natural disasters in the past and could be subject to additional seismic activities. Any earthquake or other natural disaster in these areas could significantly disrupt these manufacturing facilities’ production capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of wafers in particular, and possibly in higher wafer prices, and our products in general. Our headquarters in California are also located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, it could significantly disrupt our operations.

Changes in our tax rates could affect our future results.

Our future effective tax rates could be favorably or unfavorably affected by the absolute amount and future geographic distribution of our pre-tax income, our ability to successfully shift our operating activities to our foreign operations and the amount and timing of inter-company payments from our foreign operations subject to U.S. income taxes related to the transfer of certain rights and functions.

Risks Related to Our Common Stock

Our stock price has been and may continue to be volatile, and you may not be able to resell shares of our common stock at or above the price you paid, or at all.

The market price of our common stock has fluctuated substantially since our initial public offering and is likely to continue to be highly volatile and subject to wide fluctuations. Fluctuations have occurred and may continue to occur in response to various factors, many of which we cannot control, including:

 

   

quarter-to-quarter variations in our operating results;

 

   

announcements of changes in our senior management;

 

   

the gain or loss of one or more significant customers or suppliers;

 

   

announcements of technological innovations or new products by our competitors, customers or us;

 

   

the gain or loss of market share in any of our markets;

 

   

general economic and political conditions and specific conditions in the semiconductor industry and broadband technology markets, including seasonality in sales of consumer products into which our products are incorporated;

 

   

continuing international conflicts and acts of terrorism;

 

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changes in earnings estimates or investment recommendations by analysts;

 

   

changes in investor perceptions;

 

   

changes in product mix; or

 

   

changes in expectations relating to our products, plans and strategic position or those of our competitors or customers.

The closing sale price of our common stock on the NASDAQ Global Market for the period of January 1, 2006 to September 30, 2007 ranged from a low of $5.53 to a high of $24.55.

In addition, the market prices of securities of semiconductor and other technology companies have been volatile, particularly companies, like ours, with low trading volumes. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. Accordingly, you may not be able to resell your shares of common stock at or above the price you paid.

The pending class action litigation could cause us to incur substantial costs and divert our management’s attention and resources.

In November 2006, three putative class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, our directors, an executive officer and a former executive officer, as well as the lead underwriters for our initial and secondary public offerings. The lawsuits were consolidated and an amended complaint was filed on April 24, 2007. The amended complaint alleges certain material misrepresentations and omissions by us in connection with our initial public offering in September 2005 and the follow-on offering in March 2006 concerning our business and prospects, and seek unspecified damages. On June 25, 2007, we filed motions to dismiss the amended complaint; plaintiffs have opposed our motions, and the matter is now pending a decision by the Court. We cannot predict the likely outcome of this litigation. If we are not successful in our defense of the lawsuits, we could be forced to make significant payments to class members and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations, if not covered by our insurance carriers. Even if such claims are not successful, the litigation could result in substantial expenses and the diversion of management’s attention, which could have an adverse effect on our business.

If securities or industry analysts do not continue to publish research or reports about our business, or if they issue an adverse opinion regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock is influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us issue an adverse opinion regarding our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Substantial future sales of our common stock in the public market could cause our stock price to fall.

As of October 16, 2007, we had approximately 29.2 million shares of common stock outstanding. Of these shares, 6.4 million were sold in our initial public offering in September 2005 and an additional 2.5 million were sold in a follow-on public offering in March 2006. All of these shares are freely tradable under federal and state securities laws without further registration under the Securities Act, except that any shares held by our “affiliates” (as that term is defined under Rule 144 of the Securities Act) may be sold only in compliance with the limitations under Rule 144. The remaining outstanding shares are “restricted securities” and generally are available for sale in the public market at various times upon qualification for exemption pursuant to Rules 144 and/or 701 of the Securities Act.

In the future, we are also likely to issue additional shares to our employees, directors or consultants, as well as in connection with corporate alliances or acquisitions, and in follow-on offerings to raise additional capital. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales could reduce the market price of our common stock.

Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.

Provisions in our certificate of incorporation may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

   

the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;

 

   

the establishment of a classified board of directors requiring that not all members of the board be elected at one time;

 

   

the prohibition of cumulative voting in the election of directors which would otherwise allow less than a majority of stockholders to elect director candidates;

 

   

the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;

 

   

the ability of the board of directors to alter our bylaws without obtaining stockholder approval;

 

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the ability of the board of directors to issue, without stockholder approval, up to 5,000,000 shares of preferred stock with terms set by the board of directors, which rights could be senior to those of common stock;

 

   

the required approval of holders of at least two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or amend or repeal the provisions of our certificate of incorporation regarding the election and removal of directors and the ability of stockholders to take action;

 

   

the required approval of holders of a majority of the shares entitled to vote at an election of directors to remove directors for cause; and

 

   

the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent.

We are also subject to provisions of the Delaware General Corporation Law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for three years after the point in time that such stockholder acquired shares constituting 15% or more of our shares, unless the holder’s acquisition of our stock was approved in advance by our board of directors.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 4. Submission of Matters to a Vote of Security Holders

Incorporated by reference to Exhibit 22.1 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on August 3, 2007. (File No. 000-51532).

 

Item 6. Exhibits

An Exhibit Index has been attached as part of this Quarterly Report on Form 10-Q and is incorporated herein by reference.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    IKANOS COMMUNICATIONS, INC.
Dated: November 6, 2007     By:   /s/ MICHAEL A. RICCI
        Michael A. Ricci
        President and Chief Executive Officer
        (Principal Executive Officer)
Dated: November 6, 2007     By:   /s/ CORY J. SINDELAR
        Cory J. Sindelar
        Vice President and Chief Financial Officer
        (Principal Financial and Accounting Officer)

 

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IKANOS COMMUNICATIONS, INC.

EXHIBITS TO FORM 10-Q QUARTERLY REPORT

For the Quarter Ended September 30, 2007

 

Exhibit
Number
  

Description

10.1    Offer letter, dated April 6, 2006, between the Registrant Dean J. Westman. Incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 11, 2007 (file No. 000-51532).
10.2    Offer letter, dated September 8, 2006, between the Registrant and Nick Shamlou. Incorporated by reference to Exhibit 10.2 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 11, 2007 (file No. 000-51532).
10.2.1    Letter Agreement regarding Offer Letter, dated November 28, 2006, between the Registrant and Nick Shamlou. Incorporated by reference to Exhibit 10.2.1 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 11, 2007 (file No. 000-51532).
10.3    2007 Sales Compensation Plan for the Vice President of Worldwide Sales. Incorporated by reference to Exhibit 10.3 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 11, 2007 (file No. 000-51532).
10.4    Summary of Registrant’s 2007 Executive Bonus Program. Incorporated by reference to Exhibit 10.4 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 11, 2007 (file No. 000-51532).
10.5    Letter Agreement with Michael A. Ricci dated as of May 1, 2007. Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on May 8, 2007 (File No. 000-51532).
10.6    Stand-Alone Stock Option Agreement with Michael A. Ricci dated as of June 4, 2007. Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on June 7, 2007 (File No. 000-51532).
10.7    Restricted Stock Unit Agreement with Michael A. Ricci dated as of June 4, 2007. Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K filed with the SEC on June 7, 2007 (File No. 000-51532).
10.8    Separation and Release Agreement with Yehoshua Rom dated September 28, 2007. Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on October 1, 2007 (File No. 000-51532).
10.9    Separation and Release Agreement and Consulting Agreement with Daniel K. Alter dated October 1, 2007. Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K filed with the SEC on October 1, 2007 (File No. 000-51532).
22.1    Certificate and Report of Inspection of Election. Incorporated by reference to Exhibit 22.1 of the Registrants Quarterly report on Form 10-Q filed with the SEC on August 3, 2007. (File No. 000-51532).
31.1*    Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*    Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*    Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed Herewith.

 

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